Mr. Riggs proposes adding to the physical value a minus "going concern value," and he is logical in doing so, if it is conceded that values for rate-making rest on profits; but this the writer does not concede for an instant. Values for rate-making cannot rest on the very thing that it is aimed to regulate, to wit, the rates charged. Until engineers and public service commissions and Courts free themselves from this confusion of cause and effect, there can be no rational theory of rate-making.
Values for rate-making must rest primarily either on the actual costs of the production of a property or on estimated costs of reproduction, including therein both interest charges during construction and the sequel thereto—development expense.
Of almost as great moment as the item of development expense is the question of depreciation. The author, in common with most engineers, holds that depreciation should be deducted. This is a consequence of regarding a public service plant as if it were a machine bought in a second-hand store. A public service plant is a device which is intended to perform a given service forever. It is true that its parts are subject to wear, and must be renewed from time to time; but the plant as a whole is everlasting, or practically so. Managers of public service corporations, perceiving this fundamental truth, have rarely established sinking funds for the redemption of any considerable part of the plant. In a great railway system the renewal of a freight car is not a proportionately larger item of expense than is the renewal of a tooth in a steam shovel bucket owned by a contractor. This fact, coupled with the permanence of the railway plant as a whole, has led railway owners to make no provision for a return of the money lost in depreciation. Railway ties in a large railway system inevitably reach a condition such that their average age is exactly half the life of the average tie. Shall a sinking fund be provided for ties? If not, where does logic place a line of demarcation? When does an element of the railway plant attain a condition of sufficient importance to warrant "writing off" some of its value from the capital account? The facts are that railway managers have not "written off" anything worthy of mention for depreciation, and, in the writer's opinion, they have been perfectly logical. Consequently, the operating expenses have been much less than they would have been during the early years, had a sum been placed annually in a sinking fund. Therefore, the development expense, as deduced from the accounting records, is less than it would be if a sinking fund were provided; and the amount of this difference is precisely the amount of the depreciation. In other words, if depreciation is to be deducted from the cost of reproduction, it must be added to the development expense ascertained from the accounting records; so that, in the final analysis, depreciation should be ignored entirely in any appraisal of a public service corporation where the object is either rate-making or purchase of the corporation by the public. One qualification to this statement is needed, however, and that is that the depreciation shall not have gone far enough to result in an average age of plant less than half the life of the plant—that being the ultimate normal operating condition.
Engineers have a duty to perform, in making an appraisal of the sort under consideration, which is judicial in its character and should not savor in the least of the pawnshop. The engineer engaged by a public service commission should not for an instant make it his object to "beat down the price," no matter by what far-fetched theory he may effect the result. Nor are engineers inclined to do this, except when they regard themselves merely as agents of the public by whom they are employed. Unfortunately, many appraisers have as yet failed to realize that there is a vital distinction between the dealings that should exist in public affairs and those that actually exist in private matters involving the purchase and sale of property. In the latter case, the buyer usually takes every possible advantage of the helplessness of the seller. Is the seller ignorant? See that he remains so. Is the seller hard-pushed for money? Grind down the price accordingly. Does the seller offer goods which are a bit shop-worn? Dwell on that fact, to the exclusion of all else. Such are the tradesman's arts, and such, the writer fears, have been the arts of some appraisers of public service property.
The writer believes that, under one form of agreement or another, nearly every kind of public service can be more economically and better performed by a public service corporation than by the public itself through employees directly hired. But if America is not to pass speedily into Government ownership and operation of all public utilities, there must be a pronounced change of attitude on the part of the public toward capital now invested in public service corporations. Even as engineers, we are apt to be unconsciously influenced in our attitude toward public service corporations, not only because of the present public attitude, but because we are often put to great inconvenience by the ill-considered resistance of the corporations whose property we are called on to appraise for the public. Our duty plainly consists, first, in regarding a public service corporation as a public agent, and, second, in allotting such values that this public agent will receive a full and fair return for every dollar judiciously and honestly spent in building and developing its property. In carrying out this plan, the writer finds it wise to study the entire financial history of a corporation, going carefully through both the construction accounts and the operating accounts from the beginning.
The desirability of analyzing the actual costs of construction, betterment, and operation of public service corporations, preparatory to estimating the cost of reproduction, cannot be too strongly urged upon appraisers. Unfortunately, many corporations refuse access to their records, or claim that the records are too incomplete to be of value. However, when they realize that from those very records can be deduced one of the largest items of cost of reproduction, namely, the item of development expense, they are certain to show as much willingness as they now show aversion to disclosing their records.
The writer has recently completed an appraisal of a street railway system, the managers of which placed at his disposal the entire accounting and engineering records. From these the development expense was deduced, and forms an item which can be demonstrated in Court, if need be, instead of being the subject of unsupported "expert testimony." As far as the writer knows, this is the first time that a street railway corporation has voluntarily opened all its books for use in an appraisal which may be made public. May it not be one of the harbingers of a far-sighted action on the part of public service corporations, which will result eventually in eliminating entirely the hostile attitude of the public toward its accredited agents?
Reverting again, and finally, to the question of development expense, it will be seen, after study, that the method of deducing it from the accounting records provides for every possible item. The cost of advertising, the cost of colonization, and canvassing by agents engaged in building up the business tributary to the corporation, the cost of developing an efficient business organization and an efficient plant—every possible item of developing the business finds accurate record in the development expense deduced from the accounting records as outlined. This may not be apparent at first glance, but a little consideration proves it to be so. If, for example, $20,000 has been spent annually for ten years in advertising to secure business, the operating expenses have been increased exactly $20,000 for each of the ten years. Consequently, the annual deficit below a "fair return" on the investment has been made $20,000 greater each year than it would have been had no expense for advertising been incurred. In other words, the deficit below a "fair return," which is the development expense, shows automatically the amount spent for every such item as advertising. The writer regards this automatic register of development expenses as being one of the most important features of his method for determining such expense. It removes the entire problem from the realm of guess-work and expert testimony, and makes it a problem in engineering economics. It involves no question as to whether or not the existing rates charged for freight, or for any other service, are fair.
Arthur L. Adams, M. Am. Soc. C. E. (by letter).—This paper, in spirit, diction, and contents, is a masterly presentation of the best thought and argument, by engineer specialists and the higher Courts, concerning this difficult subject—a presentation which only one intimately associated with the question for years, as has been the author, could hope to make. It is of special interest, too, because it deals fundamentally with the Michigan railroad valuation, now ten years old, and deservedly considered somewhat ancient in the evolution of what may be termed the logic of valuation methods. The frank acknowledgment of the now apparent deficiencies or errors of that work, notably in the defective method and resulting under-valuation of real estate, as well as the upholding of that which still appears to the author to be sound in principle, are excellent manifestations of the constructive and judicial spirit so necessary to the making of any substantial contribution to the art.
Unanimity of opinion in matters of detail, even among those specializing in this line of practice, cannot be expected, especially in a general discussion. Details must receive their emphasis from local coloring and local conditions. Making allowance for these local conditions in Michigan and other contiguous States—notably conditions of population and flat topography—and remembering that the basis of the paper is a railroad valuation for purposes of taxation, and not a water-works appraisal for annual rate-fixing in a semi-arid region of rapid development, or some other widely differing utility, it seems to the writer that the author has been singularly fortunate in giving expression to views with which specialists will for the most part agree.