Case Study - China Builds Beijing-Shanghai High Speed Railway

A. Question:

The client is The Ministry of Railways (MOR) of China. The ministry is responsible for the development of the rail network and rail infrastructure in mainland China, passenger services, and regulation of the rail industry. The ministry is also in charge of the operations of China Railways which manages 16 railway bureaus and 2 railway group companies in China.

Recently, the Chinese MOR is considering investing a large amount of money to build a high speed railway between Beijing and Shanghai, the two largest cities and the two most important economic zones in China. You have been hired by the ministry to advise them on this major project. Should they go ahead with the investment? What issues must be considered before making a “go” or “no-go” decision?

B. Additional Information:

1. Comparison of regular railway and high-speed railway

• The regular railway line distance between Beijing and Shanghai is about 1,320 kilometers or 820 miles.

• Due to low speed and frequent stops, it takes about 12 hours to travel between Beijing and Shanghai by regular railway.

• The proposed Beijing–Shanghai high-speed railway will be of similar line distance, and will be parallel to the conventional railway.

• Designed for a maximum speed of 450 kilometer per hour, the high-speed train will take only 3 hours to travel between Beijing and Shanghai.

2. Population

• The population of Beijing is 19.5 million as of 2010.

• The population of Shanghai is 23 million as of 2010.

3. Capital requirement of the project

• Fixed costs: USD $2.5 billion, this includes the costs of railway infrastructure, railway stations, high-speed trains, and license of technology.

• Variable costs (operational): USD $50,000 per high-speed train per day

Tips:

To make a “go” or “no-go” decision, essentially one has to evaluate the projected profitability of the project. The candidate will have to carefully weigh the costs and benefits of the proposed high-speed railway project. The “Profits = Revenues – Costs” framework seems the right way to start with.

• Profits = Revenues – Costs

• Revenues

• Price

• Volume

• Costs

• Fixed Costs

• Variable Costs

C. Solutions:

1) Market Sizing

Estimate the passenger volume of the high-speed railway:

a. Population of these two cities:

The candidate should have a general sense of the population of Beijing and Shanghai. Let’s say 20 million people in each city. But not everyone can afford the high-speed train service, since we will probably charge a premium over regular railroad services.

b. Market size of competitive services:

• Regular railroad: The current passenger volume of regular Beijing-Shanghai railways is about 8,000 people each way per day.

• Airlines: There are 20 flights each way between Beijing and Shanghai every day. Each flight holds on average 150 people.

So, who is the high-speed train’s real competition?

• It takes 12 hours to travel between Beijing and Shanghai one way by regular railroad.

• The flight time between Beijing and Shanghai is 1.5 hours.

• Our high-speed train will take 3 hours to go between Beijing and Shanghai one way.

However, with travel time between city and airports, security check, waiting at the airport and everything else, we estimate that our high-speed train will be 1 to 1.5 hour faster than airplanes. Also, if someone is willing to spend 12 hours on a train, they are unlikely to be our target customer!

Therefore, the real competition comes from air travel.

2) Pricing:

a. Look at our cost to see what margins we need:

• Fixed costs (infrastructure): USD $2.5 billion

• Variable costs (operational): $50,000 per train each day

b. Look at people’s willingness to pay:

• Round trip flights between Beijing and Shanghai cost about RMB 3,000 or USD $500. Can we charge $500 for the high speed train, too?

One way to determine customer’s willingness to pay is through customer survey.

Based on our initial study, the number 1 criterion of our target customers (business travelers) is speed, followed by flexibility of the service schedule, i.e. we need to be servicing as frequently as the flights. We also found that we cannot charge more than $500 as corporate clients are unlikely to reimburse a price higher than the flight fare.

3) Cost-Benefit Analysis:

So, to match the airlines, we need to have at least 20 high-speed train departures each way every day, for instance, say hourly departure between 4am and 11pm.

Given our one-way travel time of 3 hours and say, another hour for cleaning, unloading, train inspection, etc., we need at least 4 trains for hourly departure in both Beijing and Shanghai, for a total of 8 trains at least. Given USD $50,000 per high-speed train per day, the total variable costs will be $50,000 * 8 = $400,000 per day.

If we are able to capture 100% of the airline market and charge $500 each round trip, we have $500 per round trip * 20 round trips * 150 passengers per round trip = $1.5 million in revenue per day. But is it realistic for us to capture 100% of the airline market?

At this stage, the candidate should ask for the penetration rate for similar projects. The interviewer can tell the candidate that the Thai government built a similar high-speed railroad system in Thailand before and their penetration rate was about 30% after three years.

If we assume a similar penetration rate for the Beijing–Shanghai high-speed railway, i.e. 30%, then daily revenue will be $1.5 million * 30% = $450,000, which is $50,000 higher than our daily cost of $400,000.

Break-even point

Given that the project has a fixed costs of USD $2.5 billion for infrastructure, it would take the Chinese Ministry of Railways roughly $2.5 billion / $50,000 per day = 50,000 days, or 50,000 days / 365 days per year ~= 140 years to break even.

Reference:

Consulting Case 101 - Bain & Co First Round Interview