Another peculiarity of railway competition, distinguishing it from competition in trade, is that there is no such thing as abandonment of the field. This is tersely expressed by Morawetz in his Corporation Law. "It should be observed that competition among railway companies has not the same safeguard as competition in trade. Persons will ordinarily do business only when they see a fair chance of profit, and if press of competition renders a particular trade unprofitable, those engaged in that trade will suspend or reduce their operations, and apply their capital or labor to other uses until a reasonable margin of profit is reached. But the capital invested in the construction of a railway cannot be withdrawn when competition renders the operation of the road unprofitable. A railway is of no use except for railway purposes, and if the operation of the road were stopped, the capital invested in its construction would be wholly lost. Hence it is for the interest of the railway company to operate its road, though the earnings are barely sufficient to pay the operating expenses. The ownership of the road may pass from the shareholders to the bond-holders, and be of no profit to the latter; but the struggle for traffic will continue so long as the means of paying operating expenses can be raised. Unrestricted competition will thus render the competitive traffic wholly unremunerative, and will cause the ultimate bankruptcy of the companies unless the operation of their traffic which is not the subject of competition can be made to bear the entire burden of the interest and fixed charges." So profoundly modified in short are the conditions of railway competition by contrast with those in industry, that it is clear beyond a shadow of doubt that a railway is essentially a monopoly. This requires no proof so far as local business, in distinction from through or competitive traffic, is concerned. It is equally true in respect to all traffic of sufficient importance to bring about pooling agreements or a division of the business, in order to forfend bankruptcy and consolidation. To attempt to perpetuate competition between railways by legislation is thus defeating its own end. The prohibition of pooling agreements which refuses to recognize the naturally monopolistic character of the business, can have but one result, namely, to compel consolidation as a measure of self-preservation. Such legislation defeats itself, bringing about the very result it was intended to prevent.
Two general theories governing the rates chargeable by railways are entertained, known respectively as cost of service and value of service. According to the first, the proper rate for transportation should be based upon the cost for carriage of the persons or goods, with an allowance for a reasonable profit over and above the expenses of operation involved. This line of argument is commonly advanced by representatives of shippers and the public, who reason by analogy from other lines of business. In several European countries when railways were first built, and afterward, especially in Germany in 1867, attempts were made to apply this principle widely in the construction of tariffs. Practical railway men, on the other hand, usually adhere to the second principle of value of service. This argument maintains that, while theoretically cost of service should determine minimum rates, owing to the nature of commercial competition, as a matter of fact rates must be based upon the principle of charging what the traffic will bear. This is accomplished by proportioning the rate to the commercial value of the service. Practically the rate is found by charging as much as the traffic will stand without evidence of discouragement. Thus if the price per bushel of wheat in New York is twenty-five cents higher than in Chicago, it would obviously be absurd to charge a rate which would absorb all of that increment of place value due to transportation. Enough margin must be left to the shipper who buys wheat in Chicago and sells it in New York, to permit a reasonable profit on the transaction, after payment of the freight rate.
These two principles of cost of service and value of service are directly opposed in one regard; inasmuch as the cost of service theory harks directly back to railway expenditure; while the value of service principle contemplates primarily the effect upon the railway's income account. Any charge is justified according to the latter view, which is not detrimental to the shipper as indicated by a positive reduction in the volume of business offered. No charge, on the other hand, may be deemed reasonable according to the cost of service principle, which affords more than a fair profit upon the business, regardless of its effect upon the shipper. As a matter of fact neither of these views is entirely sound by itself. Both have large elements of truth in them. Each qualifies the other. In the first place, it is to be noted that between them they fix the upper and lower limits of all possible charges. Less than the cost of service cannot be charged; else would a confiscatory rate result. This was the plea set up by the railways in the now celebrated Texas Cattle Raisers' Association case against the cancellation by the Interstate Commerce Commission of an extra charge of $1 per car for switching charges at Chicago. At the other extreme, more than the traffic will bear cannot be charged without a disproportionate decline in volume of tonnage. This would be bad business policy, as it could at once entail loss of revenue. The railway could not submit to the former alternative; it would not conceivably resort to the latter.
Attempts have been made by various authors to account for the phenomena of rate making on other grounds. The German author, Sax, has sought to trace an analogy between the imposition of taxes and railway charges, alleging that both should be proportioned to what the shipper "can afford to pay," from an ethical rather than an economic point of view. Acworth interprets the phrase "charging what the traffic will bear" to mean something analogous to this. His allegation is that rate schedules are built up upon the principle of "equality of sacrifice," otherwise characterized as "tempering the wind to the shorn lamb." High class traffic contributes liberally of its abundance of value, while third class passengers and low grade tonnage are let off lightly on the ground of their poverty. Taussig in his memorable contribution to the subject[139] has, however, shown how untenable this theory of "equality of sacrifice" is. Not ethical but purely economic considerations are applicable in such circumstances except, of course, in so far as common carriers, enjoying privileges by grant of the state, may be considered as imposing taxes for the performance of a quasi-public duty. This latter test of a reasonable rate has underlaid a long line of Supreme Court decisions since the Granger case.[140] Nevertheless, as so frequently happens, legal and economic bases of judgment seem to be lacking in harmony.
There can be no question that for an indispensable public service like transportation, conducted under monopolistic conditions, the ideal system of charges would be to ascertain the cost of each service rendered and to allow a reasonable margin of profit over and above this amount. To the application of this principle alone, however, there are several insuperable objections both theoretical and practical. Such cost is practically indeterminate, being joint for all services in large part, as we have seen: it is highly variable, being perhaps never twice the same, as circumstances change from time to time; cost is unknown until volume is ascertained, and volume is ever fluctuating; the cost of service, obviously, could never be ascertained until after the service had been rendered, while, of course, the schedule of rates must be known in advance, in order that the shipper may calculate his probable profits; and finally the principle of increasing returns, flowing from the dependence of cost upon volume of traffic, imposes such an incentive for development of new business, which in turn depends for its volume upon the rate charged, that cost of service is subordinated at once to other considerations in practice.
Of these objections to rate making upon the principle of cost of service alone, it would indeed appear as if the first should be conclusive. If the cost is simply indeterminable, why bother about any further refutation of the principle at all? But the persistency of the idea that somehow railway operations are analogous to the business of an ordinary merchant; and that cost and profits are ascertainable; renders it necessary to pile proof upon proof of the limitations upon its applicability to real conditions in service.
Not only is the mere cost of service indeterminable; if it could be ascertained, it would not establish the chargeable rate in many instances. The freight service of a railway comprises the carriage of all kinds of goods simultaneously, from the most valuable high-priced commodities, such as silks and satins, down to lumber, coal, cement, and even sand.[141] To compel each of these classes of goods to bear its proportionate share of the cost of carriage, would at once preclude the possibility of transporting low-priced goods at all. One dollar a hundred pounds may not be too much to add to the price of boots and shoes for transportation from Boston to Chicago.
It would still form only a small part of the total cost of producing and marketing them. But to add anything like that sum to the cost of one hundred pounds of salt or cement would put an end to the business at once. Only about so much can in practice be added to the price of any given commodity for freight without widely limiting the area of its available market. Thus raw cotton seems to be able to bear an addition of about fifty cents per hundred pounds for freight to its total cost. Experience demonstrates that anything more than this one-half cent per pound charged on cotton, entails more loss than gain. In the case of fancy groceries or fine furniture, there may be no considerable demand in any event above a certain ascertainable level of prices. For boots and shoes or cut building stone it may be that competition from some other centre of production nearby, precludes any great addition to the price for freight. The business simply will not bear more than a certain proportion of charge. Not only would the rigid application of the cost of service principle hinder all transportation of low-grade traffic; it would also prevent any development of long distance business. It is indubitable that sole reliance upon cost of service as a basis for rate making is theoretically unsound, and impossible of practical application.[142]