CC myopic obsession with on-street competition risks doing more harm than good for passengers – but will this pave the way for Quality Contracts?

Transport authorities and bus operators have often been at polar opposites when it comes to the Competition Commission’s on-going investigation. However, there is one point on which we all seem to agree – the CC’s recent obsession with on-street competition is dangerous and largely misguided. What’s more, it risks getting in the way of high-end partnerships and could take us back to the Wild West of the late 80s. But is there a chance this could pave the way for Quality Contracts?

Vintage cornflakes box

Buses cannot be treated like a typical consumer product

Buses are not like cornflakes

Despite its earlier recognition that “head-to-head competition tends towards instability, the closer the competition between operators becomes” the CC’s latest position isn’t entirely surprising. In reality, there was always a risk that it might revert back to the safe and comfortable haven of perfectly competitive markets. This is the norm for most typical consumer products, say cornflakes, where there’s a permanent threat of competitors coming along and offering a similar product at a lower price. Retailers will put the competing products on their shelves and consumers will logically buy the cheaper one, placing pressure on the incumbent to review its offer.

The problem is that bus services are a tad more complex than cornflakes. Critically, they’re perishable which means that they can only be purchased at very specific points in time. Many passengers will arrive at a bus stop at the same time everyday and will expect to board the first bus that shows up. The decision to wait around for another bus or to adjust the timing of a journey increases the non-monetary cost incurred by passengers. At the same time, if a bus turns up immediately after a preceding service it will find very few passengers to pick up. We have shown in our response to the CC’s report that for these reasons, new entry into an existing corridor at evenly spaced intervals between the incumbent’s services is very likely to be loss making, even where the incumbent is earning substantial profits.

This means that there is a very strong incentive on a new entrant to run its services immediately ahead of the incumbent’s timetable. In turn, the incumbent will respond by adjusting the departure of its services and this process will continue until one of the operators decides to withdraw from the market. Typically, the operator with the deepest pockets survives. The all too familiar by-products of this process, observed most clearly in the post-deregulation period, are an irreversible loss of demand due to network instability, short term losses to operators (eventually leading to higher fares) and an increasingly concentrated market where the law of the jungle dictates who survives.

In a sense, the CC is right – profits have never been lower than in the post-deregulation period. But paradoxically (and this is something the CC probably struggles to understand) this has not resulted in a better outcome for passengers. In the five years following deregulation, bus patronage in the metropolitan areas declined by a quarter despite a substantial increase in bus-kms. Without some degree of timetable coordination, unfettered on-street competition will lead to operators losing money and passengers getting a less reliable and more expensive service. Regrettably, the CC report has also raised serious doubts over high-end partnerships, the type of measure with the potential to achieve a more efficient and sustainable outcome in the context of on-street competition. Evidence from Oxford and Merseyside suggests that where competition has developed, Qualifying Agreements can indeed be used to offer a better and cheaper product to passengers, albeit requiring a degree of regulatory oversight from local transport authorities.

So will the CC be successful in delivering more on-street competition? And how will local transport authorities respond?

If the CC’s remedies achieve its stated objective, this could well take us back to the bus wars of the late 80s. Ironically, this would put increasing pressure on LTAs to bring in SQPs or Quality Contracts, the types of remedy that the CC has been so keen to avoid. If, on the other hand, the remedies have little or no impact, then this may act to strengthen the case for Quality Contracts and we may well see new proposals coming forward. Following the publication of the CC’s report, we have already seen announcements from Nexus and WYPTE which seem to show a growing resolve. On the other hand, the CC’s ambivalence over partnerships could lead to a growing sense of frustration amongst LTAs as operators become increasingly reluctant to participate in fear of the competition authorities. The recent findings on tacit coordination in the North East and the Wirral are only likely to compound these fears. The effect could be to force some LTAs to move towards Statutory Partnerships and possibly Quality Contracts.

So it seems possible that the CC’s myopic obsession with on-street competition could end up back firing and eventually pave the way for a more regulated market. I only wish they would have worked this out before repeating the same mistakes of the past. In the meantime, expect turbulent times ahead.

Pedro Abrantes

This article first appeared in Coach and Bus Week

How might franchising change the UK bus industry?

In its recent report, the Competition Commission concludes that local bus markets aren’t quite as competitive as was once envisaged by the architects of deregulation. This is no bad thing in itself – I expect few of us would advocate a return to the bus wars of the 1980s. The problem is that without the discipline of a competitive market larger operators are able to take home a little too much profit, largely at the expense of passengers and, often, smaller operators. So how could we introduce greater competitive pressures in the market without more wasteful competition? The Commission offers franchising as a potential solution. Indeed, this approach is now the norm across the developed world and the evidence shows it can be a powerful tool in delivering both cost savings and patronage growth. But how might franchising change local bus markets? This article tries to draw some lessons from the experience in London, the Netherlands and Scandinavia.

Lessons from London

London hybrid bus near the Houses of ParliamentOne of the most interesting examples of bus franchising is in London, where TfL is fully responsible for designing the network and tenders out around a fifth of all routes every year, with several bidding rounds each year. This steady flow of contracts has helped keep the market alive and avoids peaks of activity. TfL also takes revenue risk, thereby removing the biggest advantage held by the incumbent at re-tendering, a common problem in recently de-registered services elsewhere in the country. There are now seven medium-sized operators and two smaller ones, with an average of three bids per tender. With controls at the tendering stage to prevent any single operator from dominating this is likely to remain fairly stable in years to come. Another key feature in London is the use of quality incentives since 2000, which has reversed the decline in reliability and service quality observed in the 1990s.

Lessons from the Netherlands

Outside the UK, the Netherlands provide a contrasting model to London with large area-based contracts as the norm. The province of Limburg is at one extreme, having awarded a long term multi-modal net cost contract to Veolia in 2006 covering both rail, bus and taxi. Despite some teething problem as a result of deviations from cost and patronage forecasts, this integrated network approach has delivered both huge cost savings and substantial growth in demand. Few other franchising authorities have been quite as bold though, most of which preferring to adopt gross cost contracts subject to minimum service levels and quality incentives. However, some degree of negotiation over network design issues appears to be commonplace at the tendering stage. Overall, the Dutch approach has been effective in the difficult task of moving some large public monopolies into private ownership.

Lessons from Scandanavia

A slightly less conventional model has been developed in Norway, where reasonably efficient incumbents in some parts of the country are allowed to maintain their monopoly position but with all public subsidy awarded through highly incentivised contracts. These are typically a combination of unit payments per bus-km, per passenger and per passenger-km, varying based on local priorities (for example, with more emphasis on bus-kms in rural areas and passengers in urban areas). The objective is to ensure operators’ decisions are well aligned with public sector objectives. Underperforming operators can be replaced through competitive tendering by default, a more credible threat than Quality Contracts at present. In a way, this model is not dissimilar to Statutory Quality Partnerships with the key difference that UK transport authorities directly control little more than 10% of industry revenues, compared to over 50% in Scandinavia. Changes in subsidy flows could certainly make this a more viable model.

What does this mean for the UK?

In general, international experience suggests that there is more than one way to improve the functioning of local transport markets, with all-out deregulation possibly one of the worst models around  both for passengers (as demonstrated by the contrasting faith of London and the metropolitan areas over the past 25 years) and for smaller operators. The precise model that each UK local market ends up with in the future will depend not only on the Competition Commission but, crucially, on the current market structure, LTAs’ funding and attitude to risk. It is conceivable that some areas could end up with a Limburg-style model while others will prefer to develop something closer to current partnership arrangements. On the whole, these are very exciting times which offer the potential to deliver a more sustainable market structure, increasingly attractive bus services but, above all, long term passenger growth.

Pedro Abrantes

This article was first published in Coach and Bus Week.

How WEBs could significantly change transport investment priorities

What a tangled WEB we weave

The on-going Transport Select Committee (TSC) Inquiry into Transport and the Economy has put the spotlight once again on the link between transport investment and economic growth. While its starting point is the acknowledgement that “a good transport system is a pre-condition of (…) the UK’s economic recovery” the TSC is now tasked with revisiting the findings of the Eddington report and to answer two key questions:

  1. What types of transport investment should we prioritise?
  2. Do we have the right tools for the job?

A significant amount of work has taken place in the wake of Eddington, and especially over the past year, which suggests that the right tools do exist. The problem, I would argue, is that we are not using them in the right way. As a result, we are failing to give due weight to some of those projects which can deliver the greatest impact on jobs and the economy. I am of course talking about the treatment of wider economic benefits (WEBs) in the Department for Transport Transport’s Appraisal Guidance.

In a perfect world

It is worth taking a minute to examine the approach to appraisal currently followed by the DfT. Its key underlying assumptions are, in my view, that markets are perfectly competitive, that there is no unemployment or the potential for transport investment to influence exogenous growth.

Sorry Doc - you can't fool the DfT with that travel time saving approach

This gives rise to the DfT’s classic welfare approach which concentrates on valuing travel time savings (plus a few monetised externalities). In this parallel world, every minute of monetised travel time saved is worth the same wherever it may take place (although this does vary by trip purpose) and will eventually affect the behaviour of firms and individuals to generate a new optimal state of equilibrium across the economy.

Back to reality

The Eddington report (and before it the 1999 SACTRA report) brought these assumptions into question by recognising that, under conditions of imperfect competition (some people would call this the real world), transport can contribute towards agglomeration economies. Increased agglomeration, it has been shown, can drive up productivity and wages and may also lead towards a more efficient labour market and lower consumer prices. The impact of transport investment on agglomeration is also much more pronounced in large urban areas, where there is a much higher density of businesses and workers than elsewhere. The accelerated growth over the recent years in city centre employment in the largest UK conurbations, and the concomitant growth in rail commuting, can be interpreted as a sign of agglomeration economies at play.

The effect of transport investment on agglomeration economies and productivity was recognised by the DfT with the publication, almost a year ago, of TAG Unit 2.8 on Wider Impacts and Regeneration, which remains under consultation to this day. While this guidance document provides a robust methodology for assessing wider economic benefits of transport projects the DfT has shown no sign of intending to allow the inclusion of WEBs in the calculation of benefit cost ratios (BCRs). This is somewhat alarming given the explicit objective of the Coalition Government to re-focus spending on those projects with the potential to deliver the greatest returns in terms of economic growth. If WEBs vary between different types of scheme then excluding such benefits from appraisal would surely undermine national objectives.

But do WEBs vary to any great amount between schemes and do they have a material impact on BCRs? Well, I’m afraid that the answer is yes on both counts. With respect to the first question, a recent report by Deloitte and PBA compared several UK schemes and found that those significantly improving accessibility across large urban areas, and to city centres in particular, are likely to have much greater agglomeration benefits than inter-urban or rural projects. On the other hand, the report also suggests that while London public transport schemes produce the greatest agglomeration effects in absolute terms, higher unit construction costs mean that the impact of WEBs on BCRs is of a similar size in the capital and in the metropolitan areas.

Economic benefits of the planned Leeds trolleybus are just as significant as travel time savings

WEBs cannot be ignored
 
 

 

Turning to the second question, there’s a growing body of evidence which highlights the scale of the potential economic impact of transport investments:

  • Analysis of the Leeds trolleybus proposal by Steer Davies Gleave shows that its impacts in terms of job creation and economic output are of approximately the same order of magnitude as the direct benefits to transport users in terms of travel time savings;
  • Analysis by CEBR in the West Midlands shows that the job creation benefits of the Coventry Spirit Bus Rapid Transit and of phase 1 of the Midland Metro light rail scheme are, respectively, 30% and 50% higher than the capital cost of these schemes.
  • These findings are echoed by SDG’s analysis of the Northern Rail Hub scheme in Manchester and the Centre for Cities work on agglomeration and growth in the Leeds City Region. These reports agree that public transport schemes improving city centre accessibility can generate wider economic benefits corresponding to 20-25% of total benefits.

While some methodological issues do remain on the extent to which the totality of these benefits represent national net impacts it is clear that WEBs cannot be ignored if we are to make the right investment decisions for the economy and the public purse. At a more fundamental level, it has been argued by some that, at times of financial difficulty in particular, investment decisions should prioritise financial benefits accruing directly to the the Exchequer (such as the increased taxation arising from agglomeration economies) over those accruing to individuals (such as pure travel time savings to commuters). This is already the approach followed by some government bodies such as the Department for Work and Pensions (DWP). And while the DfT and DWP may be worlds apart in policy terms I would suggest that in the looming age of de-ringfenced budgets, localism, tight financial constraints and focus on economic growth investment appraisal needs to become increasingly consistent across departments. Instead of concentrating on improving the accuracy of existing methodologies further the DfT needs perhaps to take a step back and make sure that it is actually counting the right benefits in the first place. That should help ensure that we all get the greatest bang for our buck in the difficult times ahead.

Pedro Abrantes

This article was first published in Local Transport Today.