This article was downloaded by: [146.83.118.

10] On: 29 April 2014, At: 20:44

Publisher: Institute for Operations Research and the Management Sciences (INFORMS)
INFORMS is located in Maryland, USA
Interfaces
Publication details, including instructions for authors and subscription information:
http://pubsonline.informs.org
Developing Strategies for Maritrans Business Units
Murthy V. Mudrageda, Frederic H. Murphy, Steve Welch,
To cite this article:
Murthy V. Mudrageda, Frederic H. Murphy, Steve Welch, (2004) Developing Strategies for Maritrans Business Units. Interfaces
34(2):149-161. http://dx.doi.org/10.1287/inte.1030.0047
Full terms and conditions of use: http://pubsonline.informs.org/page/terms-and-conditions
This article may be used only for the purposes of research, teaching, and/or private study. Commercial use
or systematic downloading (by robots or other automatic processes) is prohibited without explicit Publisher
approval. For more information, contact permissions@informs.org.
The Publisher does not warrant or guarantee the articles accuracy, completeness, merchantability, fitness
for a particular purpose, or non-infringement. Descriptions of, or references to, products or publications, or
inclusion of an advertisement in this article, neither constitutes nor implies a guarantee, endorsement, or
support of claims made of that product, publication, or service.
2004 INFORMS
Please scroll down for articleit is on subsequent pages
INFORMS is the largest professional society in the world for professionals in the fields of operations research, management
science, and analytics.
For more information on INFORMS, its publications, membership, or meetings visit http://www.informs.org
Vol. 34, No. 2, MarchApril 2004, pp. 149161
issn0092-2102 eissn1526-551X 04 3402 0149
informs

doi 10.1287/inte.1030.0047
2004 INFORMS
Developing Strategies for Maritrans Business Units
Murthy V. Mudrageda
Maritrans, Inc., 2 International Plaza, Suite 335, Philadelphia, Pennsylvania 19113, mmudrageda@maritrans.com
Frederic H. Murphy
Fox School of Business and Management, Temple University, Philadelphia, Pennsylvania 19122, fmurphy@temple.edu
Steve Welch
Meredith Management Group, Inc., Station Square 3, Suite 200, 37 North Valley Road, Paoli, Pennsylvania 19301, swelch@mmg-ems.com
This paper was a nalist in the 1998 Edelman Competition. Maritrans withdrew the paper from publication because it was
involved in a takings lawsuit related to its vessels. The company has released the paper for publication because its content
no longer relates to the suit. We present the paper here as we wrote it in 1998.
As an update to this paper, we report that the company has followed through on its strategy for retrotting its vessels.
In the two years immediately following the presentation at the Edelman Competition in 1998, the market turned down
as we had forecasted and the stock price dropped. Maritrans fared better than its competitors. One that is mentioned as
having nancial difculties in the paper after building new ships under the loan guarantee program, Hvide, went bankrupt
as we predicted. Another sold its tankers to a company in the grain trade and exited the business. As the model predicted,
rates subsequently rmed and the rebuilding work in the shipyards proceeded successfully, the stock price recovered from
a range of $4 to $5 in 1999 to a range of $14 to $16 in the summer of 2003, the reverse of the stock market bubble.
The main differences between the 1998 forecasts and actual experience are that the oil companies are still wringing out
inefciencies in their logistics systems and that the cost of a new vessel keeps rising. Thus, the point when new builds will
be economical is further in the future than we originally forecast and the value of the rebuild decision is higher than we
estimated. Maritrans is still using the forecasting model and it is central to the companys planning decisions.
After the Oil Pollution Act of 1990 mandated early retirement for all large single-hulled vessels that carry
petroleum and petroleum products, Maritrans stock lost 80 percent of its value. Through a sequence of studies,
Maritrans improved its understanding of its market and developed a strategy for rebuilding its single-hulled
eet and dealing with a further threat to its protability from a government program of loan guarantees to build
new ships. We demonstrated to the US Maritime Administration that giving out loan guarantees would lead
to excess capacity and depressed rates and to government expenditures to cover loan losses. Maritrans backed
off from operating petroleum-product terminals after we showed that it would not gain synergies with marine
transportation. Combining the models for these two studies, we modeled the marine-transportation market for
the eastern United States and developed an integrated strategy for rebuilding the Gulf Coast eet. Maritrans
announced its new strategy in 1997 and its stock almost doubled, reaching levels not seen since the Oil Pollution
Act was passed.
Key words: industries: petroleum, natural gas; planning: corporate.
The Marine Petroleum Industry
The most efcient ways to move petroleum long dis-
tances are by pipeline and water. Crude oil moves
around the world in ships that can hold up to
2.5 million barrels. (A barrel is 42 gallons.) Rened
petroleum products are shipped in large volumes as
well. For example, in 1998 the United States imported
around 2 million barrels of petroleum products per
day and 8 million barrels per day in crude oil, most
of which arrived by water.
Parts of the United States are completely depen-
dent on waterborne supply. Neither New England
nor Florida has reneries or pipelines feeding in
from reneries. New England is served by imports
from Canada and Northern Europe; shipments from
New York Harbor, some of which are transshipped
imports; and shipments from the Philadelphia area
and the Gulf Coast. Florida receives the bulk of its
product from Gulf Coast reneries and imports from
the Caribbean Basin: Venezuela, Trinidad, and the
US Virgin Islands.
Maritrans traces its history to before the Civil
War. Originally the company moved coal in canal
boats from the mining regions in Pennsylvania to
Philadelphia. It was incorporated in 1928 and in
1987 became publicly traded. Today Maritrans has
revenues of around $130 million per year and oper-
ates three separate eets that serve three different
149
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
150 Interfaces 34(2), pp. 149161, 2004 INFORMS
markets. The company moved 10 billion gallons of oil
in 1997. One eet serves New England and other des-
tinations in the Northeast with rened products from
Philadelphia and New York. Another eet ofoads
crude oil from incoming tankers in Delaware Bay
(Andrews et al. 1996), reducing the combined weight
of the vessels and cargoes and the draft of the
tankers so that they can sail up the channel to the
Philadelphia area reneries. This process is known
as lightering. The third eet moves petroleum prod-
ucts in the Gulf of Mexico. Traditionally Maritrans has
operated barges and tugs. The company acquired four
ships in 1997. The lightering and Gulf Coast eets
include integrated tug-barge units and ships. Sev-
eral of the vessels in these eets can operate in both
businesses, with the lightering vessels having more
specialized equipment than the others. Smaller tug-
barge units serve New England, moving appropriate
lot sizes for this market. These vessels are too small to
operate in the Gulf (Maritrans sold this eet in 2000).
Through the 1970s and 1980s, the domestic mar-
ket for marine movement of petroleum products was
at with rates that declined in real dollar terms.
During this period, Maritrans Gulf Coast eet was
protable because the company was the pioneer in
large, integrated tug-barge units, which offer the
lowest-cost service in this market. In the wake of the
Exxon Valdez oil spill, the United States government
required petroleum tank vessels in US waters to have
two hulls instead of one. This mandatory early retire-
ment of single-hulled vessels took away a large por-
tion of the value of Maritrans eet.
Maritrans developed a strategic plan to respond
to the challenges posed by the legislation based on
a set of models we developed for evaluating strate-
gic alternatives. The plan grew out of responses to
a sequence of events, and we used the technology
developed in these responses to gain deeper and
deeper insights into the business. Management sci-
ence offered Maritrans a new perspective on its busi-
ness and became an important part of the discussions
that led to the strategic plans for a potential new busi-
ness in the Northeast, for improvements in the ser-
vices of the lightering eet, and for a way to continue
as the low-cost supplier of transportation services in
the Gulf Coast (Figure 1).
The Tank-Vessel Market and
the Oil Pollution Act of 1990
To develop a strategy, a rm must understand how
the market in which it operates functions. We began
by looking at the characteristics of vessel supply and
demand and how prices are formed in the market-
place. Tank-vessel supply is best understood by look-
ing at the supply of existing vessels along with the
1992 93 94 95 96 97 98

N
o
t
O
n
e
D
r
o
p

i
n
i
t
i
a
t
i
v
e
L
i
g
h
t
e
r
i
n
g
s
i
m
u
l
a
t
i
o
n
M
a
r
A
d
l
o
a
n
g
u
a
r
a
n
t
e
e
s
s
t
u
d
y
C
h
e
s
a
p
e
a
k
e
s
t
u
d
y
M
a
r
i
n
e
m
a
r
k
e
t
m
o
d
e
l
S
t
r
a
t
e
g
i
c
p
l
a
n
&
n
e
w
b
u
i
l
d
s
R
e
b
u
i
l
d
f
l
e
e
t
E
a
s
t
C
o
a
s
t
l
o
g
i
s
t
i
c
s
s
t
u
d
y
$10
$5
S
t
o
c
k
P
r
i
c
e
Figure 1: The timeline of strategy development using management sci-
ences overlaid on the stock price shows that Maritrans stock price
improved, partly because of the benets resulting from a sequence of
actions based on the studies.
determinants of capacity expansion and contraction.
To understand the market demand, one has to study
the supply and demand for petroleum products, and
the patterns of product distribution as well.
The oil tank-vessel industry has many small compa-
nies operating in a fragmented market. Consequently,
we can use models of perfect competition. Maritrans
is one of the largest independents in the US domestic
trade with revenues of around $130 million and net
assets in vessels, terminals, and equipment of $197
million. Although many companies operate in the
business, each tends to operate in its own niche,
which is dened by a combination of location and
equipment. Several family-run companies operate out
of New York Harbor to serve the Northeast market.
Several companies operate ships in the Gulf Coast
while a few others operate integrated tug-barge units.
Another company handles much of the West Coast.
Capacity expands and contracts based on rates,
construction costs, government loan guarantees for
new construction, and Coast Guard mandated safety
requirements. The volume moved on existing vessels
depends on the locations of renery capacity, con-
sumption, imports into major ports, and distribution
patterns of the individual companies.
Maritrans customers are the integrated oil com-
panies and oil reners that move petroleum prod-
ucts from their reneries to distribution terminals
(Figure 2). The major Gulf Coast reneries have
access to pipelines that move products through the
Southeast into the Northeast and serve the Midwest
and plains states. Consequently, Gulf Coast reneries
are not totally dependent on the coastal regions of the
southern and eastern states as markets. Depending on
margins, their product can and does move in many
directions.
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
Interfaces 34(2), pp. 149161, 2004 INFORMS 151
Baltimore
Washington
Jacksonville
Port Everglades
Delaware City
Wilmington
Salisbury
Norfolk
Richmond
Harrisburg
Charleston
Savannah
Portland
Portsmouth
Boston
Providence
New Haven
Wilmington
Tampa
Yorktown
P
a
s
c
a
g
o
u
l
a
N
e
w
O
r
l
e
a
n
s
H
o
u
s
t
o
n
L
a
k
e
C
h
a
r
l
e
s
P
o
r
t
A
r
t
h
u
r
New York
Philadelphia
Corpus Christi
Rotterdam
Canada
Refineries
Import sources
Terminals
Venezuela
and St. Croix
Figure 2: The map shows the petroleum supply and demand locations on
the East and Gulf Coasts and the sources of imports. Domestic rener-
ies, shown in italics, and foreign sources, which are underlined, supply
petroleum products to terminals along the Gulf and East Coasts.
Oil companies typically sign term contracts with
shipping companies for one to two years. These con-
tracts provide rate stability and vessel utilization, but
they are not long enough to guarantee cash ow for
new investment. The agreed-upon price reects the
utilization of equipment in the market at the time
of the signing and expectations about future utiliza-
tion. Some oil companies also use the spot market to
round out their needs. Except during peak-demand
periods in the winter, spot prices are generally below
contract prices and uctuate considerably during the
year. Given the length of the contracts, the market
prices adjust continuously to the supply and demand
for shipping.
A major feature of the domestic shipping industry
is its complex legal environment and the importance
of political decisions in affecting industry economics.
The US domestic eet operates under the jurisdiction
of what is known as the Jones Act. The Jones Act is
Section 27 of the Merchant Marine Act of 1920. This
act restricts the market for movements between two
US ports to US ag vessels; that is, vessels that are
operated with US crews, owned by US citizens or cor-
porations, and built in US shipyards.
The act follows the tradition of what are known
as cabotage laws, which have existed since the 16th
century. Although this law is a clear trade restriction,
certain of its aspects are reasonable policies. The
US crew requirement applies, for example, to all
transportation industries. The government does not
allow non-US citizens unrestricted opportunity to
drive trucks, y airplanes, or run trains between
two US cities. The ownership restrictions make sense
to the extent that non-US companies operate under
much more favorable tax treatment and the US Coast
Guard has more stringent safety rules for US vessels
than other countries have for their eets.
The US-built restrictions are unique to the marine
industry and are the equivalent of prohibiting Airbus
from selling airplanes to US airlines for domestic
ights, which is clear protectionism. The purpose of
this restriction is to provide work to US shipyards
during slack periods in navy construction programs.
This requirement almost doubles the cost of building
a ship. From time to time, the federal government
provides loan guarantees to assist owners with the
high cost of construction. However, as we describe
later, these loan guarantees have the potential to dis-
tort the marketplace.
Because of the environmental consequences of oil
spills, the federal government has long regulated
tankers. The most recent legislation, the Oil Pollu-
tion Act of 1990 (OPA-90), passed in response to the
Exxon Valdez oil spill, requires that all new vessels
that carry petroleum or petroleum products be dou-
ble hulled and that the existing, single-hulled eet of
vessels above a certain size must be retired on a xed
schedule. Most of the single-hulled ships must go by
2000 (and did) and single-hulled barges by 2005.
Maritrans faced a premature end to its eet and the
reality that current rates would not support the con-
struction cost of new vessels. In fact, real revenues
per barrel-mile had declined 29 percent between 1982
and 1997. With the future value of Maritrans eet
truncated, investors acted accordingly. The stock price
declined from $10 at the beginning of the legisla-
tive debate to below $2 in 1992 as the market came
to understand the implications for Maritrans future
earnings. By 1995, when Maritrans started using man-
agement science, the stock price had recovered to
around $5, and by 1997 it went above $10 (Figure 1).
During the early 1990s, Maritrans focused on
running the business to maximize cash ow, cut-
ting overhead, and reorganizing into more closely
managed operating divisions. How to replace retiring
single-hulled vessels remained a question because
rates were not rising to a level that would provide an
acceptable return on new construction, and customers
were not willing to commit to long-term contracts of
ve years or more, which would have reduced the
risk of construction. The company kept studying its
options but nothing obvious appeared.
Since the energy crises in the 1970s, the oil indus-
try has been going through radical changes. The oil
price collapse in the mid-1980s intensied efforts to
lower costs. Along with this, evolving government
regulations on improving air quality tightly specied
the characteristics of gasoline, turning it into a com-
modity. Furthermore, with commodity markets set-
ting crude oil and product prices, cost became the
focus for renery and logistics operations.
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
152 Interfaces 34(2), pp. 149161, 2004 INFORMS
When oil products became commodities, oil com-
panies began reducing costs by engaging in what
are termed exchanges. An exchange works as fol-
lows. Company A supplies Company B in City C,
and B supplies A in city D. When Company A takes
gasoline from Company B, it gets the gasoline with-
out Bs additives and then puts in its own. As long as
the exchange is barrel for barrel, cash changes hands
based on an agreed-upon sharing of the joint trans-
portation savings with no accounting for potentially
differing costs of gasoline at their respective reneries.
Each exchange reduces the miles the average barrel
travels and, in turn, reduces the demand for shipping.
The Post OPA-90 Response
Once the oil companies saw what Exxon had to pay
for the clean-up and damages and saw the increased
liability they faced under OPA-90, many began reduc-
ing the volume they moved over water, a process that
continues today. Consequently, the declining market
for transportation services led to continued overca-
pacity despite increasing consumption of oil products.
To address the liability provisions in OPA-90
that increased the penalties for oil spills, Maritrans
embarked on a major quality initiative, known inter-
nally as Not One Drop. The initiative had a dra-
matic impact on reducing oil spills, and Maritrans has
won and continues to win awards from the US Coast
Guard for its quality initiatives.
Part of the quality strategy was the assumption that
the oil companies would be willing to pay for the
increased quality of service and that Maritrans would
be able to more than recoup its OPA-imposed costs
by charging premium rates. However, the oil compa-
nies were reluctant to pay any premium for reduced
spillage and reductions in other accidents. This did
not mean that Maritrans stopped its quality program.
It had become part of the identity of the rm, and
it had benets in reducing some other costs in the
company. Furthermore, Maritrans quality initiatives
matched those of its customers, and Maritrans has
been able to get business over other competitors with-
out quality programs when the price was the same.
The quality initiative altered the way the company
viewed its business processes and the way it operated.
The company began taking a systems view of the
organization, its processes, and its market. Still, the
company did not address the longer-run issues of
the OPA-90 deadlines.
A New Threat to the Gulf Coast
Business Emerges
The end of the cold war surprisingly created a new
threat to Maritrans Gulf Coast business and led
to the next step in better understanding Maritrans
markets. The US Navy reduced its shipbuilding activ-
ity and the large, politically connected shipyards
needed work. To keep busy until the next round of
navy contracts, they, along with the navy, encouraged
Congress to pass a program of loan guarantees for
commercial ships built in US shipyards. A loan guar-
antee provides that the government will repay loans
when ship owners default. A guarantee lowers the
cost of capital to the government rate, thereby lower-
ing the cost of a vessel. The Maritime Administration
(MarAd) is responsible for providing and administer-
ing the loans.
The guarantees posed a major threat because new
vessels meant more overcapacity and even lower rates
(Figure 3). Furthermore, the subsidized competitors
would have vessels that would last beyond the life of
Maritrans vessels, potentially disrupting Maritrans
customer relationships as 2005 approached.
Maritrans asked the management sciences group at
Computer Command and Control Company (4Cs) to
produce a policy analysis to present to MarAd. This
group had just completed a project for Maritrans on
its lightering business that helped Maritrans retain an
$11 million business with a major customer (Andrews
et al. 1996).
At the time we were doing our study, MarAd
had given out loan guarantees for four ships and
had several applications pending. Maritrans was con-
cerned about a gold rush for the loan guarantees,
because at the time member nations of the Organi-
zation of Economic Cooperation and Development
(OECD) were negotiating to eliminate subsidy pro-
grams for shipyards and a treaty seemed imminent.
Ship owners would be willing to take a few years
of losses in trade for lower vessel costs. The expec-
tation was that the guarantees would end after those
granted for construction beginning in 1998.
Rates
Tonnage
Lost revenue
per ton
Demand
Supply without
loan
guarantees
Supply with
loan
guarantees
Figure 3: Loan guarantees lower interest costs and shift downward the
supply curve of capacity. The market then clears at a lower price. The
lower revenues for existing vessels weaken the ability of current ship own-
ers to acquire new vessels through existing cash ow.
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
Interfaces 34(2), pp. 149161, 2004 INFORMS 153
Maritrans had to convince MarAd that its loan
guarantees would increase the supply of tonnage
to an already oversupplied market, leading to loan
defaults and heavy government losses. Furthermore,
we had to show that giving out the loan guarantees
would violate a legislative requirement for due dili-
gence in lending.
MarAd Pricing Model
We decided to do an economic analysis of the Gulf
Coast market to demonstrate that new vessels would
not be protable and that giving loan guarantees
in the current market would violate the congres-
sional mandate to lend responsibly. This was impor-
tant because prior to the savings and loan crisis,
MarAd had the highest number of loan defaults of
any agency of the federal government. The govern-
ment had to cover $2.3 billion worth of defaults in the
1980s.
This project included two parts that became rele-
vant for future analyses at Maritrans. First, we con-
structed and estimated a model, the MarAd pricing
model, that demonstrated the relationship between
capacity utilization and price (Appendix). With this
model, we quantied the reduction in rates for
each additional ship MarAd subsidized. Second, we
showed that imports could penetrate key markets if
rates rose enough to support new vessels.
Although the MarAd pricing model has a simple
functional form, it represents a major step forward
in understanding the structure of the industry. Peo-
ple in the industry had been gathering data for years,
but they had not been structuring it in a way that
provided insight into the real nature of price forma-
tion in the petroleum-distribution business. One rea-
son that the information had not been synthesized
into a model until this point was that no one had com-
bined the data, which came from disparate sources.
Another is that people too often focus on trees and
not the forest.
When working in an industry, one too often treats
data as a summary of a collection of events and then
focuses on the events rather than the thread of the
story told in the data. One needs a framework for
synthesizing the disparate data series. The story told
in this equation is one of supply and demand leading
to price formation, a basic economic principle. As a
counterpoint, it is easy to misapply basic economic
principles by not knowing the institutional features
and events that underlie the data.
Why we were able to achieve the insight we did
is very simple. We had a group of people who had
complementary skills, knowledge, and perspectives.
We came together as a team, and we were willing
to try new things. Furthermore, the leadership in the
company started acting on the new perspective we
offered.
We realized that if rates rose high enough to sup-
port new builds, the US petroleum industry would
lose major segments of the Florida market to more
economical imports. We learned this by understand-
ing the character of the solution to the transportation
model and how the simplex algorithm behaves. What
is essential to understand in this calculation is that
the product prices are constantly uctuating. So, bas-
ing the calculation on current product prices provides
little evidence that these markets will be lost. What
we were able to show is that if European reners can
ship economically to New York, they can also make
a prot shipping to the Atlantic coast of Florida, a
much stronger statement because it is independent of
the world price of oil.
Let P
GC
, P
NY
, and P
NE
be the (unknown) prices in
the Gulf Coast, New York, and Northern Europe.
Assume oil ows from the Gulf Coast to New York
and Jacksonville and ows from Northern Europe
to New York. Using the transportation costs C
GC, NY
and C
NE, NY
and knowing that oil ows from the Gulf
Coast and Northern Europe to New York in equilib-
rium, we have
P
GC
+C
GC, NY
=P
NY
=P
NE
+C
NE, NY
,
or
P
GC
+C
GC, NY
C
NE, NY
=P
NE
.
Knowing that P
GC
+C
GC, J
=P
J
- P
NE
+C
NE, J
must hold
for the trade to remain entirely domestic, we then get
C
GC, J
- C
GC, NY
C
NE, NY
+C
NE, J
.
This is essentially the reduced-cost calculation with a
simplex pivot in the transportation model. (Greenberg
and Murphy (1985) discuss how prices relate in the
context of a market equilibrium.)
Doing the above calculations, known as netbacks
in the industry, using rates that would recover the
cost of a new ship, we showed that if imports from
Northern Europe were economic in New York, they
were economic along the Atlantic coast of Florida
to Port Everglades, which serves Miami. This meant
that imports would be cheaper than cross-Gulf move-
ments for a signicant portion of the Florida business.
Furthermore, the impact on shipping is magnied
because these destinations are further from the Gulf
Coast reneries and use more ton-miles of vessel
capacity per barrel moved.
Policy formulation and analysis involve many dif-
ferent players with different interests and skills. A
competitor of Maritrans presented an analysis on the
same subject to MarAd before we had a chance to
present ours. That rm hired a large transportation
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
154 Interfaces 34(2), pp. 149161, 2004 INFORMS
consulting rm to do its report. This analysis proved
far too simplistic for the problem. The consulting rm
used a decision tree to calculate the probability of
loan defaults and expected losses. The idea was to
use the expected losses to show that MarAd would
not be meeting its due diligence requirement. In the
tree, the rm did not sort out properly the deci-
sion nodes from the random outcome nodes and had
applied a set of probability weights to MarAd deci-
sions, which should have formed a decision node. In
a meeting with this company, the MarAd people saw
the aws in the decision analysis. They showed that
as soon as they xed on a reasonable number of loan
guarantees and represented the decision node prop-
erly, the model really demonstrated that loan guaran-
tees to more vessels met a reasonable due-diligence
requirement.
The competitors presentation weakened Maritrans
position in our subsequent meeting with MarAd. Yet
the logic of our presentation was simple: Rates did
not support new construction. If the rates were to get
high enough to pay for a vessel, the market would be
much smaller, the remaining routes would be shorter
hauls, and the existing Maritrans eet would be able
to outcompete the new ships. Our cash-ow analysis
showed that the owners of these ships would default
without other inows to cover the losses.
Our meeting lasted more than twice as long as
MarAds representatives had expected. They could
not break our arguments, and they had to agree that
we made sense. We left knowing we had scored
points and hoping they would become more con-
servative in their approach to giving out additional
loan guarantees, because they had been warned of the
potential for defaults and could no longer claim due
diligence.
Maritrans became vocal in educating others in
the industry about our calculations on the potential
impact of imports. We do not know precisely to what
extent our study had an effect on MarAd. We do
know that MarAd did not issue any further loan guar-
antees for oil tank vessels and that our competitors
submitted no new applications. Our best guess is that
we helped MarAd to reduce the number of loan guar-
antees from 19 to eight vessels. We estimated MarAd
would have lost $20 million of the $50 million in con-
struction costs per vessel or $220 million if it had
built all 19. Our current forecast also shows that had
these vessels been built, by 1998, rates would have
dropped, causing a bottom-line revenue impact of at
least $65 million over a six-year period for Maritrans
alone. As we write this paper (in 1998), one company
that owns four vessels with loan guarantees has nan-
cial difculties. (It eventually went bankrupt.) A joint-
venture partner in a second company withdrew, and
the shipyard building the ships had to take an equity
position in the second company.
Maritrans Looks at Diversication
Despite OPA-90 and low rates, Maritrans has had a
strong cash ow because its existing eet has been
working. Maritrans started thinking about several
investment options. First, it could replace the entire
eet with new construction. Second, it could rebuild
the existing vessels to qualify for OPA-90 regula-
tion. Third, it could opt for diversication to reduce
its dependency on marine logistics only. Technical
experts ruled out the second option because of costs.
Maritrans was seriously considering the rst option
but wanted to wait for higher rates. Maritrans also
looked to diversify.
During the early 1990s, the oil companies were sell-
ing their terminal assets and using third-party facili-
ties, taking advantage of scale economies in logistics
while reducing their inventories through better man-
agement. The physical facilities they were selling were
high quality and well maintained. Maritrans thought
it saw an opportunity for protably redeploying its
assets in providing the combined exchange, transport,
and oil storage and distribution, termed distribution
services.
To succeed in the terminal business, one has to be
a consolidator, buying out the competition in each
market. The xed costs of operating a terminal are
large, and the variable costs are negligible. That is,
the business has signicant economies of scale. This
also applies to the marine business in that large tug-
barge units have the same crew size as small tug-
barge units. The goal was to combine the economies
of scale in both terminals and vessels in a way that
lowered oil companies costs and provided a good
prot to Maritrans.
The company began to bid for and acquire oil stor-
age terminals. However, this business had problems.
One of the reasons oil companies and terminal oper-
ators were selling their businesses was that oil com-
panies were improving their downstream logistics,
the portion of the business from the renery gate to
the customer. By carrying smaller inventories, they
needed less terminal storage capacity. So, the ter-
minal market was plagued with overcapacity in the
slow-growth regions of the country. The overcapac-
ity meant that margins were thin. However, Maritrans
believed it could create synergies with the marine side
and develop terminal storage into a protable new
venture.
The distribution-services concept proved to be a
hard sell to the integrated oil companies. Even though
they were divesting themselves of terminals and con-
tracting for terminal services, they would deal only
among themselves when it came to trading products.
Encouraged by the success of the lightering model
and the insights from the MarAd study, Maritrans
decided to study the growth potential of creating a
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
Interfaces 34(2), pp. 149161, 2004 INFORMS 155
rationalized system for the Chesapeake Bay region.
Maritrans already had two terminals in the area and
could acquire more.
Understanding the value of the distribution-
services concept became the next management science
goal, which led to our developing the suite of strate-
gic models that Maritrans used to develop its double-
hulling strategy.
Chesapeake Bay and East
Coast Logistics Models
We wanted to understand how the market for petrol-
eum products worked in the Chesapeake Bay and
East Coast region. We developed data that allowed us
to understand price formation in the Northeast region
and the potential for ows between supply points and
terminals. The data showed that the New York Har-
bor spot price was closely linked to the Gulf Coast
price. This made sense because around 750,000 bar-
rels per day move through Colonial pipeline from the
Gulf Coast to the Northeast. The same-day prices in
our data differed by the pipeline tariff. The correla-
tion is not perfect because of the time lag to move
the oil from the Gulf Coast to New York Harbor. Fur-
thermore, companies that own shares of the pipeline
can ship economically with narrower price differences
because a portion of the tariff returns to them as
pipeline prots. Also, the pipeline can reach capacity,
and the price difference then represents the costs of
shipping by other modes. Figure 4 shows the price
differences for one of the years we examined. The cor-
relation was much tighter with home heating oil than
gasoline for two reasons. First, heating oil is sold as
an unbranded commodity where price is paramount;
whereas, gasoline is branded and some companies
prefer to sell their own gasoline. Second, gasoline
0
20
40
60
80
100
120
140
-0.2 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 2.2 2.4 2.6 2.8 3
NYH-GC price difference ($/bbl)
F
r
e
q
u
e
n
c
y
Reformulated gasoline Home heating oil
Figure 4: The probability density function of the New York-Gulf Coast price
difference shows the extent to which prices track pipeline tariffs of approx-
imately $1.00.
price relationships become less stable when compa-
nies make transitions between different formulations
to meet summer versus winter specications.
The conclusions from this data analysis are not
surprising from an economics perspective. However,
they were surprising to the people who had to deal
with the day-to-day crises. Because they spent so
much time on the exceptions, they had come to think
of the exceptions as the rule.
We built a simple transportation model for Chesa-
peake Bay to see what the rationalized ow patterns
with exchanges would be given the pipeline infras-
tructure, renery capacities, and potential marine
links. We developed several insights. First, some arbi-
trage opportunities existed because of imperfections
in the price relationships between the Gulf Coast
and New York Harbor. Second, the marine compo-
nent would never be large. Third and most important,
after we looked at the physical processes, we found
no operational synergies between the marine and ter-
minal businesses. The value Maritrans could create
by expanding its terminal business was not some-
thing that Maritrans could retain, and in the end, it
could hurt what shipping business the company had
in the bay.
Also, the oil companies did not want to partici-
pate in Maritrans distribution system. The reason is
clear from a game-theory perspective. What they did
instead was not only to engage in exchanges but also
to share terminal capacity, reducing their need for ter-
minals and for marine transportation. When sharing
terminals and making exchanges, each oil company
knew that its partner-competitor would cooperate
because each had a hold over the other in some mar-
ket. That is, the cooperative game has a core with
savings shared among the oil companies. If Maritrans
did the consolidation, Maritrans would have mar-
ket power relative to the oil companies and could
keep a portion of the gain. The oil companies recog-
nized this and did not want to place themselves at a
disadvantage.
East Coast Logistics Models
We expanded the model to include the Eastern
Seaboard from Georgia to New England. The goal
was to understand better the pattern of economic
marine moves. We gained further insight into the role
of imports in supplying the East Coast and where
the potential existed for new opportunities. For exam-
ple, using dual variables, we could ask how far rates
would have to be cut to build a service between
Philadelphia and ports in New England. Again, we
saw a few opportunities, but nothing that could pro-
vide signicant growth for Maritrans.
With the completion of the analysis, Maritrans real-
ized it had no comparative advantage over other
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
156 Interfaces 34(2), pp. 149161, 2004 INFORMS
operators in making terminals protable. Like the
marine business, terminals suffered from overcapacity
and thin margins. Unlike the marine business, termi-
nal capacity could not move to protable opportuni-
ties or be sold off in world markets. Maritrans backed
off from the distribution-services concept, stopped
buying terminals, and sold off one of the terminals the
company had purchased (and later sold the remaining
terminals).
When we undertook this study, Maritrans was seri-
ously considering the purchase of four terminals and
probably would have incurred $2 to $3 million in
further losses if it had made these acquisitions. The
insights provided by this model prevented it from
buying these terminals.
Developing a Strategic Plan
for the Gulf Coast
The OECD efforts to eliminate the shipyard subsidies
collapsed in part because the US was unwilling to
sign a treaty to eliminate subsidies. This meant that
those companies that built vessels under the early
loan guarantees now have the highest-cost capac-
ity, which is not paying for itself during the current
period of low rates. Further, the potential gain from
having a lower capital cost than future builds without
loan guarantees no longer exists because MarAd can
still provide guarantees.
From the market response to the quality program,
what became clear was that Maritrans had to be the
low-cost provider. Also, our modeling of the North-
east and Mid-Atlantic markets showed that Maritrans
had to further understand its markets now and into
the future, in particular, future rates and the trade
routes that will continue for the foreseeable future.
We had to understand which markets represented the
best long-term potential and how Maritrans could be
the least-cost provider to those markets.
We recognized that we had to structure our anal-
ysis around four questions: What is the demand for
transportation services? What is the nature of the
trade from the customers perspectives? What are the
appropriate vessels? What are the nancial implica-
tions? Figure 5, which evolved with our analysis,
appeared in Maritrans 1996 Annual Report to explain
the strategic dimensions to the stockholders.
As a rst step, we had to understand the effects
of logistics on the petroleum marketplace. A trans-
portation model shows the extent to which petroleum
movements can be reduced, because each simplex
pivot is essentially a new exchange in the language
of the petroleum industry. Using a small LP model
of the Gulf Coast, we saw that through their existing
exchanges, the oil companies had moved to within
ve percent of the optimal solution.
Vessel size,
Trade routes,
Customer needs,
Timing,
Economic order
quantity.
What to build?
How to build?
Cost reduction.
Product demand,
Vessel demand,
Imports,
Retirements,
Rate forecast.
Internal rate of
return,
Economic
value added,
Stockholders.
Trade
Demand
Vessel
design
Financial
Figure 5: The eet replacement analysis as described in the 1996 annual
report illustrates the way Maritrans used a suite of models to understand
the market and make strategic decisions.
Given that normal uctuations occur in the mar-
ketplace with over- and undersupply and random
changes in demand, ve percent of the transporta-
tion optimum is probably as good as these companies
can get on this cost component, given that they are
managing a larger system. Consequently, exchanges
would not continue to shrink the market to any great
extent. We could see that some ports even had the
potential for growth.
We realized that we had been working towards the
right model for understanding the logistics patterns
on the East and Gulf Coasts. With our transportation
model of petroleum movements, called the East Coast
Logistics Model, and our MarAd Pricing Model, we
had two of the key pieces for building a full market-
equilibrium model for marine-transportation services.
The missing pieces were a representation of supply
and an integrating structure for combining the pieces.
We developed the missing pieces, put together what
we needed into a unied model called the Maritrans
Marine Market Model, and began looking for market
opportunities. These turned out to be selected short-
haul routes that Maritrans already serves.
The Maritrans Marine Market Model
The model we describe here is the current stage (as
of 1998) in the evolution of the models we use to
forecast the marine markets. It falls into the category
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
Interfaces 34(2), pp. 149161, 2004 INFORMS 157
of economic-equilibrium models in that it incorpo-
rates a representation of the supply of transporta-
tion services and demand for transportation services
and nds market-clearing prices based on supply and
demand. This kind of model is used typically in gov-
ernment for policy analysis or by consortia of rms
to perform industrywide studies. We know of no uses
in corporate strategic planning.
We estimate the supply of domestic vessels by
counting those capable of working in the domestic
trade and which of those are likely to move into
clean products from related markets, such as black
oil (crude and residual oils) and chemicals. We also
add in planned builds under MarAd loan guarantees.
Using the costs of a model vessel, we allow currently
unplanned builds to enter the market at breakeven
economics. This has the effect of capping rates at the
cost of new construction.
We use a transportation model to estimate the
demand for tonnage. In the model, all of the ren-
ery regions have limits on their capacity. Total sup-
ply exceeds total demand because these reneries
serve more than the East and Gulf Coasts, and we
presume they sell their excess supply elsewhere. We
pick a Northern European and a domestic rening
center to set baseline product prices and examine
the import/domestic rening trade-offs. In den-
ing scenarios, we adjust the import price relative
to the domestic price and vary the growth rates in
petroleum supply and demand.
If one solves a linear program and the model has
excess capacity, the capacity has zero value. However,
in reality the market places a value on capacity well
before it is fully utilized, and this value appears in
the price. The MarAd pricing model links price to
capacity utilization and compensates for this inade-
quacy in the way LP models represent market prices
in the dual.
With a transportation model representing demand
for shipping, the MarAd pricing model representing
the pricing, and data describing the existing eet,
we nd the market equilibrium by manipulating
the transportation costs in the transportation model
until we reach a consistent set of prices and quanti-
ties. We do this for each year in the forecast period.
(We describe some of the technical aspects in the
Appendix.) Using a sequence of single-period solu-
tions is appropriate in this market because contracts
cover one to two years. The spot market operates con-
tinuously and provides the basis for price formation
in the contract market.
When building policy and planning models, one
needs to design an appropriate set of scenarios and
understand the effect of modeling choices on model
results. For example, models that minimize cost have
dual variables that can understate market prices when
the model represents only a part of a larger eco-
nomic system. One then compensates for this in the
way one interprets the results. To scope out possi-
ble futures, one typically designs optimistic and pes-
simistic scenarios. In our case, optimistic means high
rates, high equipment utilization, and increased prof-
its, and pessimistic means low rates, a glut of vessels,
and reduced protability.
Our representation of new capacity can be con-
strued as optimistic or pessimistic. It is optimistic in
that it presumes MarAd will be responsible when
providing loan guarantees and will not encourage
oversupply. It is pessimistic to the extent that vessel
owners are concerned about the political risks of the
Jones Act under freer international trade and have
been burdened with low rates for an extended period.
Consequently, ship owners may wait for a period of
above-normal rates before committing to new builds.
The demand model for transportation services is
pessimistic. Because oil companies optimize more
than just transportation costs, on many occasions they
would be willing to incur higher transportation costs
when other opportunities for prot exist. However,
the model does lay out the pattern of transportation
ows towards which the industry has been moving.
Furthermore, one can use dual information to under-
stand those ports where minor perturbations in the
market can alter the ow patterns.
Results
Figure 6 shows a rate forecast where the rates decline,
followed by a period of stability. As capacity nally
exits because of OPA-90, rates rise and new builds
become more economical. As rates rise, the distances
moved shrink and imports penetrate further. We were
able to identify the uncontested markets for domestic
product. Figures 7 and 8 show the ow patterns from
1 5 0
1 6 0
1 7 0
1 8 0
1 9 0
2 0 0
2 1 0
2 2 0
2 3 0
1
9
9
7
1
9
9
9
2
0
0
1
2
0
0
3
2
0
0
5
2
0
0
7
2
0
0
9
Year
R
a
t
e
Optimistic
Pessimistic
60
100
Figure 6: The rate forecast from January 1997 shows a dip in rates from
increased capacity, followed by increases as capacity retires and demand
grows.
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
158 Interfaces 34(2), pp. 149161, 2004 INFORMS
0
50
100
150
200
250
300
1
9
9
7
1
9
9
9
2
0
0
1
2
0
0
3
2
0
0
5
2
0
0
7
2
0
0
9
Year
V
o
l
u
m
e

(
K
B
b
l
s
)
Source 1
Source 2
Source 3
Source 4
Short haul
Long haul
Figure 7: Changes in ow patterns serving Port-1 illustrate the increasing
importance of short-haul movements.
rening centers into two markets over time. These g-
ures show that the mix of renery centers serving a
port is likely to change dramatically over time.
The results should be tempered by several factors.
The reduced costs on the nonbasic activities show that
minor variations in the world and domestic prod-
uct markets can lead to more protable opportunities.
That is, normal market uctuations increase oppor-
tunities in markets that are uneconomic on average.
If demand growth in the Southwest and Midwest
exceeds expansions in renery capacity, then there
will be less pressure to ship from the Gulf Coast to
the East Coast. Last, European reneries, like their
US counterparts, have been restructuring, and excess
capacity relative to domestic demand could shrink
over time, lessening the role of imports from Europe.
0
50
100
150
200
1
9
9
7
1
9
9
9
2
0
0
1
2
0
0
3
2
0
0
5
2
0
0
7
2
0
0
9
Year
V
o
l
u
m
e

(
K
B
b
l
s
)
Foreign S1
Foreign S2
Source 1
Source 3
Short haul
Long haul
Figure 8: The changes in ow patterns serving Port-2 show increased
import penetration.
Developing the Strategy
Prior to our developing the Marine Market Model,
Maritrans held internal discussions about building
ships and what would be the optimal ship for the
marketplace. The company also signed a contract to
build four ships. However, the models showed that
the real competition for the long-haul routes was
imports and not other ships. Furthermore, ships are
less suited for short-haul routes than integrated tug-
barge units. Ships have a higher daily cost but sail
faster than tug-barge units. In the short-haul routes,
the vessels spend a higher proportion of their time in
port rather than sailing, making the integrated tug-
barges the economical vessel type.
A debate ensued on how best to continue to serve
the tug-barge market. A competitor built a 250,000-
barrel barge with a 10,000-horsepower tug. Maritrans
current eet has capacities from 175,000 to 250,000
barrels, and the tugs have 6,000 horsepower. The
250,000-barrel barges have the advantage of meet-
ing the volume needs of the largest customers, and
the larger horsepower increases speeds from 10 knots
with the existing tugs to 13 with the new tugs. Some
wanted to match the competition and build equiva-
lent units. Under this scenario, Maritrans would build
an entirely new eet with larger barges and new tugs.
Model results showed that new builds couldnt be
supported by the rates at least until 2005. We con-
cluded that we had to stay with our existing barges
and nd a way to extend the life of our barges.
Maritrans again looked into the option of rebuilding
the vessels with a different emphasis.
We developed a new optimization model based on
the nonlinear programming model to look at opti-
mal barge sizes in terms of what could be done with
the existing eet and the economics of adding horse-
power to the tugs. The model evolved into one that
optimizes the timing for rebuilding the barges using
the prices from the forecasting model.
The ad hoc elements of the study became the
basis for a formal plan that linked four separate
pieces into a unied analysis. The pieces were the
market-equilibrium model, the vessel-timing model, a
vessel-nancial model, and a model for studying ves-
sel technical design and cost (Figure 9).
Throughout 1997, we exercised the Marine Mar-
ket Model to look at potential opportunities. The
company rened the designs, and we used the opti-
mization model to test ideas. By the fall of 1997,
Maritrans signed a shipyard contract to double hull
one of its Gulf Coast barges, starting in the spring of
1998. The rebuild design has been successful, and the
company is scheduling the double hulling of seven
more barges before their OPA-90 retirement dates.
Maritrans also signed contracts with two oil compa-
nies that were ending their involvement in marine
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
Interfaces 34(2), pp. 149161, 2004 INFORMS 159
Chesapeake
model
East coast
logistics
model
MarAd pricing
model
Supply model Demand model
Figure 9: The model interrelationships reect the growth from the
Chesapeake model and the MarAd pricing model.
transportation and in the process acquired four of
their ships. Maritrans interest in entering into these
new agreements was raised by the market analyses
we had been doing. Maritrans has committed $75 mil-
lion to eet replacement and expansion. In 1997, the
price of the stock rose nearly 60 percent (Figure 1).
Benets
Although the primary focus of the analysis activities
was on developing strategies for Maritrans eets, the
company beneted in several other ways. The com-
pany avoided losses by not taking proposed direc-
tions, it reorganized to match the conclusions reached
in the analyses, it derived current benets in bidding
for work, and it sees many future benets from ongo-
ing analytic activities.
In the strategic-planning process, we developed a
realistic view of the future economic environment
that helped us to develop our 10-year plan. The
analysis gave direction and justication for Mar-
itrans eet-expansion efforts. It focused company
efforts on maintaining a low-capital-cost advantage.
This work became the basis for discussions on how
to increase shareholder value. The total savings
Maritrans achieved over building new tug-barge units
by rebuilding the existing eet is $220 million in
reduced capital expenditures. The company has com-
mitted itself to an additional new-capital-equipment
program, spending $75 million on additional capac-
ity and reconstructing much of the existing tug-barge
eet. The current depreciated value of vessels, ter-
minals, and equipment is $162 million. The value of
the companys stock rose nearly 60 percent from the
beginning of 1997 to the beginning of 1998, reecting
investor condence in our strategy and results.
The company avoided losses in several different
areas. By not pursuing the integrated distribution ser-
vices strategy, the company avoided losses of $2 to $3
million on the four terminals it was seriously consid-
ering acquiring. To the extent that MarAd reduced the
number of loan guarantees for ships from 19 to 8, the
federal government avoided $20 million in losses per
ship for a total of $220 million. By using the Marine
Market Model to estimate market prices with and
without the added vessels from loan guarantees, we
expect that Maritrans avoided revenue losses on the
order of $65 million over a six-year period. Because all
of Maritrans equipment would have operated at the
lower rates, the costs would have been the same and
these losses would have owed to the bottom line.
The series of models has helped us to identify
areas of strategic strength and of growth potential. We
have achieved immediate economic benets because
of the accuracy of our near-term forecasts. Because
the forecasts showed the persistence of low rates,
rather than betting on potential higher-priced oppor-
tunities in the spot market, Maritrans was aggressive
about obtaining contracts to secure utilization, avoid-
ing near-term exposure to variable market rates. It
has also been aggressive in disposing of assets that
did not have long-term prot potential. As a result,
Maritrans divested $5.6 million of assets in 1996 and
$5.1 million in 1997.
The forecast has been accurate because shipping
tonnage cannot be increased quickly: from order to
delivery, shipyards typically take from 1.5 to 2.0 years.
Also, the growth pattern in demand for petroleum
products has been stable, and reliable forecasts from
industry experts and the Energy Information Admin-
istration exist.
We expect important future benets because the
development of the strategic models has shown the
value of management science throughout the organi-
zation. Currently, we are working on several tactical
models. These models will improve scheduling pro-
cesses by both improving eet utilization and helping
Maritrans customers better manage inventory. Mari-
trans will continue to use our analytic capability to
demonstrate the value of integrating Maritrans ser-
vices into customers supply chains. An important
dimension to marketing in an industrial setting is to
demonstrate the value of your services beyond the
sole focus on price. We are developing the tools for
Maritrans to do this in its Northeast and Gulf Coast
operations as we did for the lightering business.
As mentioned before, the local computer soft-
ware and consulting rm Computer Command and
Control Corporation (CCCC) had done the initial ana-
lytical work in partnership with Maritrans. Maritrans
liked its work so much that it entered into an
agreement to hire all of CCCCs management science
personnel and put them on its staff early in 1997. To
paraphrase the commercial, we liked the razor so
much we bought the company.
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
160 Interfaces 34(2), pp. 149161, 2004 INFORMS
Appendix
The Maritrans Marine Market Model predicts trans-
portation rates given tonnage availability in the mar-
ket and the demand for this tonnage, which is derived
from the demand for the product transported. This
is an economic model that combines supply with
demand, and it is known as a computable economic
equilibrium model.
The MarAd Pricing Model
The MarAd Pricing Model relates price to spare ship-
ping capacity and is an econometric model estimated
from time-series data on rates, petroleum movements,
and shipping capacity. The rates used are called
American tanker rates (AR rates) in the industry and
are an index that provides a unied structure across
all shipping routes.
The shipping market can be viewed as a queu-
ing system, where queue congestion grows asymptot-
ically as demand approaches shipping capacity. The
value of capacity grows with increased congestion.
We use the formula for the wait in an A/A/S queue
to approximate prices as a function of congestion:
p
|
=o+p S
|
,(S
|
D
|
), where (1)
p
|
=price in time period |,
S
|
=supply of tonnage in time period |,
D
|
=demand for tonnage in time period |, and
o, p =regression constants.
As demand for tonnage approaches supply, the
denominator in (1) goes to 0. This causes rates to
move towards innity.
To adapt this model to the Marine Market Model
we modied it as follows. Because our interest is
in the tonnage in the Gulf Coast market and the
South Atlantic, we make a priori estimates of the
tonnage demanded in other markets. Consequently,
the demand component consists of two parts, one
xed and the other variable. With this assumption, (1)
becomes
p =o+p S,(S D
]
D
.
), where (2)
D
]
=xed component of the demand for tonnage,
and
D
.
= variable component of the demand for
tonnage.
The equation is specied as if we have estimates of
supply and demand and are forecasting the AR rate.
This is the way in which we estimated and originally
used this model. However, in the equilibrium model,
we view demand as a function of price and rewrite
the equation as follows:
D
.
=(p op) S,(p o) D
]
. (3)
To use this model, we need estimates of the supply
of vessels and the demand for transportation services.
The next model shows how we estimate demand.
The East Coast Logistics Model
The basic transportation model formulation is as
follows: Let
be the set of all reneries, supply locations,
) be the set of all terminals, demand locations,
q
i
be the ow from i to , and
c
i
be the transportation cost between i and .
|p 1:
Minimize

i
c
i
q
i
subject to

q
i
S
i
, (4a)

i
q
i
D

, where i and ) . (4b)

Let |
i
be the round-trip time and port time in days
from to i and back to . The conversion factor from
barrels to deadweight tons (dwt) is 8.2 bbl/dwt. To
supply one barrel per day, we need 8.2/|
i
deadweight
tons. Therefore, to support a ow of q
i
on the link
i to , we need q
i
|
i
,8.2 dwt. The sum of all the
terms q
i
|
i
,8.2 is the demand for shipping in the
model and is balanced against the tonnage supply
curve. We combine the two models into the Marine
Market Model using a specialized algorithm based on
Murphy and Mudrageda (1998).
Samuelson (1952) showed the equivalence between
the optimization solution and market equilibrium at
the theoretical level (Figure 10). The area below p
c
and
above the supply curve is known as producer surplus.
This is the extra prot above costs and a market
rate of return on capital. The area below the demand
curves and above p
c
is the extra utility consumers
receive beyond paying the market price and is called
consumer surplus. One nds the market-clearing price
and quantity by maximizing an objective function that
Demand
(East coast logistics model)
p
e
Quantity
P
r
i
c
e
Supply
(MarAd pricing model)
q
e
Consumer
surplus
Producer surplus
Figure 10: A price/quantity pair that maximizes consumer plus producer
surplus is a market equilibrium.
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.

Mudrageda, Murphy, and Welch: Strategies for Maritrans Business Units
Interfaces 34(2), pp. 149161, 2004 INFORMS 161
has as its solution the area covered by the consumer
surplus plus the producer surplus. The objective func-
tion is the inverse of the demand curve minus the
inverse of the supply curve. This is equivalent to look-
ing at the curves in Figure 10 with q as the indepen-
dent variable. What we have described is a variant
of this.
Acknowledgments
Scott Andrews of Maritrans and Lewis Rockwood of
Growth Associates contributed to the work described here.
Janice Smallacombe at Maritrans helped us write this paper.
References
Andrews, S., F. H. Murphy, X. P. Wang, S. Welch. 1996. Modeling
crude oil lightering in Delaware Bay. Interfaces 26(6) 6878.
Association of Ship Brokers and Agents. 1997. American Tanker Rate
Schedule. Milbourne, NJ.
Greenberg, H. J., F. H. Murphy. 1985. Computing regulated mar-
ket equilibria with mathematical programming. Oper. Res. 33(5)
935955.
Maritrans, Inc. 1996. Annual Report. Philadelphia, PA.
Murphy, F. H., M. Mudrageda. 1998. A decomposition approach
for a class of economic equilibrium models. Oper. Res. 46(3)
368377.
Samuelson, P. A. 1952. Spatial price equilibrium and linear pro-
gramming. Amer. Econom. Rev. 42(2) 283303.
Stephen VanDyck, CEO of Maritrans, made the
following remarks during the Edelman competition:
Maritrans was a company whose very existence
was threatened. Our entire eet of single-hulled ves-
sels was outlawed by regulations passed by the
US Congress. A government agency was interfering
in our market in a way that was going to make things
worse. We attacked these problems with a suite of
strategic models.
The real rates per barrel moved declined by 29%
between 1982 and 1996. We faced declining margins
and potential extinction. We had to survive and
prosper in the transition to market of double hulls
from single hulls, requiring massive investments in a
market unprepared to pay for them.
Our market models produced surprising results.
The traditional assumption in our business was
build it and they will come. For the rst time we
actually solved the problem the correct way. We found
out in the beginning how much we could actually
pay. Then we began the process of getting there. We
started out with a cost of $350 million and worked to
a cost of $150 million. An accurate prediction of the
market dynamic was essential. We learned the opti-
mal eet deployment and investment decisions and
learned we could not afford to build new double-
hulled vessels.
We developed a successful strategy in a commod-
ity market. We often know more about this market
than the major oil companies. This is a real-world
technology success story.
D
o
w
n
l
o
a
d
e
d

f
r
o
m

i
n
f
o
r
m
s
.
o
r
g

b
y

[
1
4
6
.
8
3
.
1
1
8
.
1
0
]

o
n

2
9

A
p
r
i
l

2
0
1
4
,

a
t

2
0
:
4
4

.

F
o
r

p
e
r
s
o
n
a
l

u
s
e

o
n
l
y
,

a
l
l

r
i
g
h
t
s

r
e
s
e
r
v
e
d
.