Armenian Railways: Five Year Business Plan

Marketing & Pricing 2.1Introduction

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2Marketing & Pricing


Armenian Railways is a short-haul, landlocked rail network of some 750 active mainline kilometers. Most domestic rail hauls are less than 300 kilometers, as are linkages to border crossings from the major population and production centers. The railroad carried nearly 35 million tons of freight and five million passengers annually at the end of the Soviet era. It now handles only a fraction of that amount.
Armenia, both in the Soviet era and today, is dependent on rail deliveries of foreign energy, foodstuffs and raw materials, and produces finished products that are not necessarily shipped by rail. Rail imports consistently outweigh domestic and export traffic. In 1989, 53% of rail freight traffic was imports, 24% exports and 22% domestic. In 1999, at much lower volumes, imports were 57% of traffic, exports only 12% and domestic traffic 31%.
After independence, railway transport volumes for all railroads in the Caucasus—Armenia, Georgia and Azerbaijan—declined sharply. Before independence, AR lines carried more tonnage than the Georgian Railway. Important flows included imports of oil, grain and construction materials from Soviet republics and exports of industrial products to Russia and other Soviet states. These were shipped via Azerbaijan. Although less direct, this routing was preferred during Soviet times because it freed the Tbilisi-Baku line for passenger traffic. The Azerbaijan route was closed with the Nagorno-Karabakh conflict following independence.
As shown in the figure, the decline in freight tonnage was severe for all three Caucasus railroads, but AR was particularly hard hit. By 1995, AR traffic fell to a fraction of that of either Georgia or Azerbaijan. Since 1995, freight volumes have remained at or below 1.5 million tons (less than 5% of former levels), and passenger volume has dropped by 75%. The border closings during and following the Azerbaijan conflict contribute to Armenia’s especially difficult situation, and future traffic prospects depend in part on border reopenings. Most heavy industry in Armenia has closed and the country has experienced substantial population out-migration.
In 1999 Armenian rail freight traffic lingered at levels of a small short line carrier, dominated by just a few commodities and heavily weighted by essential imports. Total 1999 freight tonnage was just under 1.5 million tons. As shown in the figure, almost half of this traffic was petroleum and grain imports, with other imports (mostly food products and fertilizer) also significant. Domestic traffic comprised only 31% and exports only 12% of Armenia railways total volume. With all borders except the connection with Georgia closed, Armenian Railways currently carries no transit traffic. Though now much emphasized as a potential growth opportunity, it should be noted that transit tonnage was minor even during the peak volume years of the Soviet period.
Armenia Railways carried about 1.3 million passengers in 1999, down from some 4.6 million a decade earlier and 3.0 million in 1995. As shown in the figure below, some 84% of all Armenia Railway passengers traveled an average length of less than 30 kilometers and the average trip length for all domestic passengers (98% of the total) was less than 50 kilometers.
Even in 1989, AR passengers made mostly domestic trips with average journey distance of 83 kilometers. Thus, when borders were closed, passenger traffic volumes were less catastrophically affected than freight.
In western Armenia, the rail system passes though many small towns and villages bypassed by main roads. Some of the most heavily traveled portions of the Armenian rail network are not closely paralleled by the highways, so that short haul rail travel is in substantial part a result of the unavailability of convenient road alternatives. If Armenia is to transition from uneconomic short-haul rail passenger transport to more economic motor transport, attention may need to be given to improving rural feeder roads.

2.2Pricing & Policy Issues

Given the drastic decline in traffic, AR needs to identify pricing and marketing strategies to grow profitable lines of business and minimize unprofitable lines of business. This analysis must take into account the constraints imposed by government tariff policies and the requirement to provide uncompensatory public services.

2.2.1Freight Policy & Tariff Issues

The current Government tariff policy requires that all freight be carried at a uniform rate of US$ 0.024 per tonne-km.3 As shown in the figure below, this rate is moderate compared to freight rates elsewhere in the world. Given the light density nature of most of AR’s traffic, the extremely low lengths of haul and the availability of good roads in Armenia, nearly all AR traffic is likely to be truck competitive. Proposals

AR recognizes that that a uniform tariff, related to neither cost nor demand, hampers its ability to compete in the transport marketplace, and is bad for AR and for the economy of Armenia. In some cases the price is too high and drives traffic to truck or prevents it from moving altogether. For example AR marketing officials believe that a lower price could double domestic cement traffic. In other cases, the price is too low and keeps AR from realizing much needed revenue or even covering its costs.
The Transportation CJSC has proposed several modifications to the tariff regime that would provide it with some freight pricing flexibility. These modifications are principally proposals for cost-based adjustments, carefully drafted to avoid conflicts with non-discrimination provisions that are contained in the Armenian Civil Code.4 They include proposals that:

  • Tariff policy should avoid equalization of charges for different commodities, which might have different transport costs.

  • Tariff policy should take into account the value of rolling stock used during transportation, given different investment and operating costs.

  • The value of the transported commodities, as well as the need for the Railway to conduct operations without losses should be considered.

  • Extra costs associated with small volume commodities should be considered.

  • Cost peculiarities associated with owned or rented empty wagons should be considered.

  • Provision should be made for offering discounts.

To support the above proposals, the Transportation CJSC then composed a tariff list it proposed to apply in the year 2000. As in the case of old Soviet tariff lists, this list is designed to set in advance the formulas that would take into account cost variations and other factors that would be accepted as legitimate variations from uniform pricing. Rates would be changed only at pre-established intervals and subject to a process of bureaucratic and political approval.

Modest as the above proposals are in relation to cost-based pricing variations that were long sanctioned by the Ministry of Railroads of the Soviet Union, the Armenian Government has yet to accept them. Constraints include:

  • Reluctance to risk departures from uniform transport pricing that might undermine the recovery of the Armenian economy.

  • A perceived need to seek concurrence of other former CIS railroads, given that more than two thirds of Armenian Railway traffic involves joint movements with Georgian Railways and other CIS railroads.

  • A desire to avoid conflict with the new Armenian Civil Code, which prohibits discrimination in transport as part of a broader effort to support fair business dealings and reduce corruption.

In addition, the Government appears to perceive that freight rail operations at least break even, thus removing the urgency for reform. In the present environment, therefore, movement toward greater pricing freedom is likely to move slowly.

In keeping with most transport economists, hwtsl judges that railway freight pricing should generally be set by shipper demand. This is particularly true for a very short haul carrier, such as Armenian Railways, where truck poses substantial competition for domestic traffic.5 In addition, some two thirds of Armenia Railways business is import or export business where the Armenian railway share of the total rail rate or of delivered prices is relatively small. In these cases Armenian rail prices should be price-inelastic, offering opportunities for more complete cost recovery, while not substantially affecting end product markets or prices. A transition to demand-based pricing should therefore be advocated. Changes to Enhance Freight Revenues

Given the Government’s reluctance to move towards more market-based pricing, hwtsl recommends four interim strategies for enhancing rail revenues.

  1. Advocate for AR current pricing proposal. Some elements of demand based pricing are encompassed within the railroad's recommendations and might be expanded over time.

  1. Develop a policy on railway discounts in a manner that avoids conflict with the Civil Code. Discount policy should be progressively broadened to sanction the use of transport contracts under defined conditions.

  1. Deregulate prices for transit traffic. These prices would not directly affect Armenian citizens and Armenian transit routes will be intensely competitive with routes not traversing Armenia. Therefore, Armenian Railway should be allowed maximum rate flexibility to negotiate with both CIS railroads (Georgian and Azerbaijan railways) and non-CIS railways (Turkish and Iranian railways) to develop this business. It may also be politically feasible to move fairly quickly to deregulate rail rates for export companies, where the exporter's concern is for a total transportation package, rather than for the modest Armenian portion of the rail journey.

  1. Allow Infrastructure CJSC to sell access to foreign rail operating companies (subject to full customs and security controls) to traverse Armenian rail lines at commercial rates. It is entirely possible that developing some transit business may not be possible without eliminating handing by multiple carriers.

The Government does not appear to be requiring AR to operate freight services that do not cover short-term variable costs or could not do so with cost reduction measures. Where freight traffic has been light, services have been reduced or discontinued. For that reason, PSO arrangements for freight do not appear necessary. However, Government does need to recognize that the railroad will need to cover long run incremental costs, not just short run variable cost, if it is to provide adequate rail service over the longer term. Armenian Railways has plans to reduce its unit infrastructure maintenance and rolling stock costs, which could in theory reduce rate requirements. In view of deferred maintenance for both infrastructure and equipment and the age of the fleet, however, falling unit costs are unlikely to eliminate the need for upward price adjustments in the near term. This means that the railroad will require, at a minimum, the pricing flexibility sought by the railroad in its recent proposals.

2.2.2Passenger Policy & Tariff Issues

Like freight rates, passenger fares are set by the Government of Armenia. AR passenger fares are some of the lowest in the world. They are far below cost recovery and AR recognizes that they are uncompensatory. At a rate of roughly three drams per kilometer (actual rates determined by a zone system), an average fare for a 30 kilometer trip is only 90 drams or about US$ 0.17.
In 2000, passenger revenues are forecast to cover 8% of the passenger business unit’s costs. Excluding Infrastructure CJSC costs, which could be considered fixed in the short term, passenger revenues cover 13% of the passenger business unit’s costs.
Passenger service is unlike to ever recover the cost of service from the fare box. As noted earlier, some 84% of rail passengers (1999 data) use the train for local trips averaging only 29 kilometers. The 14% of rail passengers making somewhat longer regional trips still travel an average of only 47 kilometers. Only 2% of Armenian Railways passengers use the international train to Georgia, where the average trip length of 254 kilometers is possibly sufficient, accompanied by much fewer train stops, to allow some potential for variable cost recovery.
In addition, domestic train riders are mostly rural poor, who cannot afford significantly higher fares than the current low rates. Many passengers appear using the train to bring produce to market. Raising fare would likely drive away such traffic, reducing rather than increasing revenue. Changes to Enhance Passenger Revenues

Given the constrained market situation, the loss on passenger traffic must be addressed through other policy changes. Options available to the Government of Armenia include:

  • Permitting the railroad to abandon some passenger service.

  • Providing a Public Service Obligation (PSO) payment for essential services.

  • Make transfers from the freight sector to the passenger sector transparent in the form of a tax that can be evaluated publicly along with other tax policies.

If the government of Armenia wishes to provide public transportation to rural and poor communities, it should evaluate and fund the most economic option for providing that service. If the most economic is not rail, AR should be allowed to discontinue passenger services. If the most economic option is rail, the government should provide funding for rail services.

With its precarious financial situation, however, Government is unlikely to provide sufficient PSO payments (or tax relief) to enable the railroad to cover variable costs without cross-subsidization from freight services. Hwtsl strategy recommendation is based on the assumptions that government will require AR to:

  • Operate the international passenger train because it is deemed to be a vital national connection to the outside world.

  • Operate most of the domestic routes due to the current absence of convenient road alternatives in many cases and the consequent dependence of the local (particularly rural) economy on rail service.

Recognizing this adverse situation, the business strategy for passenger service should be to minimize the losses from passenger service and oppose demands for increased service that would increase the loss. Recommended tactics include:

  1. Make no investments in domestic passenger equipment and infrastructure, beyond what is minimally necessary to provide the service levels mandated by government at an acceptable level of passenger safety. With typical passenger journeys in the 20-50 kilometer range, no track rehabilitation should be undertaken to increase passenger train speeds and infrastructure investment should be driven by freight requirements.

  1. Adjust services based on availability of road access and number of travelers as a basis for service adjustments. For stops with competitive road alternatives, service should be reduced or eliminated.

  1. Seek inflation increases on base fares.

  1. Charge supplemental fees for passenger accompanied goods beyond a certain standard volume.

  1. Seek pricing freedom on summer train service from Hrazdan to Sevan and through service from Yerevan via Hrazdan to Sevan (used for vacationing). This could be a test case for later liberalization of other domestic passenger rates.

  1. Avoid actions that would encourage demand for expanded routes and schedules.

  2. Seek rate increases on two highest classes (closed compartment and premium closed compartment) of international rail service. Seek additional pricing freedom with respect to goods carried on the international passenger train.

  1. Explore opportunities for sharing costs of the international train with Georgian Railways.

  1. Continue to press for Public Service Obligation subsidy. If an explicit Public Service Obligation arrangement is not feasible, seek to commit the 20%VAT charged on passenger tickets to a passenger fund and/or for tax relief.

It is projected that if the above measures are adopted, Armenian Railways rail passenger service can be held to no growth from Year 2000. This should be the railroad target for the five-year business plan.

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