Bus Service Industry in Britain

Introduction

The bus industry in Britain was regulated by Road Traffic Act 1930 after a rapid growth in the 1920s. In half a century, local bus service provision was dominated by publicly owned companies. In 1984, Department of Transport issued White Paper Buses which argued that regulation had led to excessively high cost, inadequate innovation and a structure of internal cross-subsidy which was both inequitable and inefficient. It also suggested that most of the problems of the industry would be overcome if restrictions on entry were removed. That proposal was implemented in the 1985 Transport Act. Accordingly, local bus services in Britain (excluding London) were deregulated in October 1986. The term “deregulation” referred to three major changes which consisted of (1) abolition of the quality controls provided by the Road Traffic Act of 1930; (2) privatization of the National Bus Company and reconstitution of municipally owned companies and (3) subsidy reduction[1]. Since then, local bus services have been provided by private operators as either commercial services or supported services subsidized by the Local Transport Authorities (LTAs). London bus services were not deregulated, they operate on the franchise system where private bus operators bid for the contract to run a specific route for the specific period, usually five years. This coursework aims to study economic effects on the scope in which bus services should be regulated or deregulated.

To serve the mentioned objective, I divide my papers into four sections. Section 1 and 2 will deal with bus service industry and current regulatory framework in Britain, respectively. Thereafter, Section 3 will analysize the effects of regulated and deregulated services to local bus market. Finally, Section 4 will make a conclusion on the extent local bus transportation should be regulated or deregulated.

1. Bus service industry in Britain

1.1. Structure of the industry

After deregulation, there were a fierce competition among small bus operators and also a consolidation trend leading to the creation of several large operating groups which have subsidiaries in different areas.

Bus industry has become a large industry with recent commercial revenues of approximately £2.4 billion and public subsidy receipts equivalent to £1.2 billion. In 2007/08 almost 3.1 billion local bus journeys were made in Great Britain, excluding London[2].

It is estimated that local bus services in Great Britain are involved by about 500 operators, both supported and commercial. Of these operators, there are nine major bus operating groups with four large national bus operating groups including First Group plc, Stagecoach Group plc, Arriva plc and The Go-Ahead Group plc. These other five operators are considered as regional groups, as they operate predominantly in one or two core geographic areas. These are National Express Group plc; TransDev plc; Kinch Group Ltd, Veolia Transport and East Yorkshire Motor Services Ltd. It can be said that the industry in Great Britain represents a condensed structure composed of a large number of small operators, very large operators (1,000 buses or more) and not much at the middle.The four national bus operating groups occupy about 67 percent of the bus fleet in deregulated market (that is, Great Britain, excluding London)[3].

1.2. Types of service provision

There are two types of service provision in the bus network in Great Britain excluding London. These are commercial services and supported services.

1.2.1. Commercial services

Commercial services are run by the bus operators without requirement for any specific public subsidy. The bus operator only needs to meet conditions for granting of a Public Service Vehicle (PSV) license to start the running of commercial services. After finishing the period of notice for route registration, a bus operator is entitled to run or cancel any service.

1.2.2. Supported services (regulated services)

Some bus routes which are unable to operate for commercial purposes and are considered socially necessary These services are supported or tendered services. They are operated by private operators and subsidized by LTAs although there are some municipally owned operators and not-for-profit operators.

There are three main forms of Government funding for local bus services: public transport support for certain bus routes which are socially necessary but not commercially viable (awarded by competitive tender unless falling under the de minimis limit), concessionary fare reimbursement (available to all bus operators) and the bus service operators’ grant (BSOG) (available to all bus operators).

Within the scope of this course work, I will mainly focus on supported services awarded by competitive tender as in my opinion, the extent to which local bus transportation should be regulated or deregulated will be clearly examined. More particularly, I provide hereafter the procedure of providing supported services in Greater Manchester. This illustrates a mechanism in which supported services are provided by private operators and subsidized by the LTA

In Greater Manchester, the Greater Manchester Integrated Transport Authority (GMITA) works on behalf of all Greater Manchester to deliver the local public transport system for the city region. Additionally, it works in partnership with private companies that provide local bus tram services and is also in charge of investing public money to subsidize local bus services. Under GMITA, there is an organization called Greater Manchester Passenger Transport Executive which is responsible for implementing policies and decisions of the Authority. It undertakes a very wide range of duties regarding to local bus services, from operating bus stations to procuring subsidized bus services. The largest part of GMITA’s funding derives from a levy on the Council Tax paid by resident to their local council. In 2009/10, this levy equates to £ 64.30 per person in Greater Manchester and the total amount comes to £ 164.74 millions[4].

If there is a route which is not considered economically viable for operators to operate services commercially but communities need to have access to public transport, GMPTE do this by subsidizing commercial operators or supporting local community transport organizations to run services on this route. The contract to run the route is put out to tender and bus operators submit bids for the contract. These bids will specify the amount of subsidy that the operator requires to run the service. The awarded operator has to run the service to the conditions provided in the contract.

2. Legal framework

The current legal framework within which local bus services are operated in England and Wales (outside London) is provided in the Transport Act 1985. In Scotland, long distance journeys had been deregulated by the Transport Act 2005.

After that, the 2000 Transport Act was promulgated to strengthen powers of LTAs. According to the Act, LTAs are empowered to ask bus operators to meet certain quality standards based on Quality Partnership Scheme (QPSs) and Quality Contract Schemes (QCSs). It also allow LTAs to set up ticketing schemes that require local bus service operators to make and implement arrangements to accept each other’s ticket or provide integrated ticketing in ways specified in the schemes.

More recently, the Local Transport Act 2008 has introduced several changes to increase the powers of LTAs. Additionally, it also made further amendments regarding to QPSs and QCSs and introduced new provisions about Voluntary Partnership Agreements (VPAs) and other qualifying agreements.

3. Effects of Deregulated and Regulated Services

To examine to what extent the local bus industry in Great Britain should be regulated or deregulated, in this section I will focus on effects of both deregulated and regulated services.

3.1. Deregulated Services

Regarding to deregulated services in the local bus service market, at a regional level, many large areas and many counties have one very large player with high market share (for example, Aberdeenshire, Cornwall, Lincolnshire, Isle of Wight, West Midlands). Many towns have only a single player of any significance (for example Aberdeen, Bristol, Brighton, Cardiff, Cambridge, York). There are a third of LTAs (containing one-fifth of the population) are served by only a single national operator. According to OFT’s market research[5], prices only reach competitive levels when three operators are present in local market. As a result, only the threat of entry to the industry by new operators will encourage operators to keep competitive prices and service standards high. In the local bus market, barriers to entry are bus, depot and maintenance facilities. All three elements illustrate the fact that entry into this industry is straightforward. However, there is an issue regarding to bus depots which are owned or leased by an operator and are exclusively used by that operator. It may lead to exclusionary behavior to impact on local bus market. (Case: Cardiff Bus Company engaged in predatory behavior[6]). Exclusionary behavior damages competition in the following ways.

(1) If successful, it leads to a loss of competition on the bus route in question, reducing the incentive for the incumbent to provide a good value, frequent and reliable service.

(2) By denying a competitor access to one route, it may reduce or remove the competitor’s ability or incentive to enter the incumbent’s other routes.

(3) by being seen to act in this way towards possible entrants, the incumbent may develop a reputation for aggressive response to any entry or competition from other operators. This reputation may deter potential entrants who might otherwise have entered the market.

Additionally, the local bus service market research of OFT also estimated that the average fare is nine per cent higher when there is only one national operator providing commercial services than when there are two or more national bus operators providing services.

In conclusion, owing to deregulated local bus services’ characteristics, the new entry in the market is limited and incumbent operators may abuse their position to charge higher prices and offer poorer services.

3.2. Regulated services

According to Ken M. Gwilliam[7], one of the most contentious issues that collapses most economic and technical opposition to deregulation has been whether the bus market is truly contestable. He used Baumol (1982) model that the essential technological requirement for a market to be contestable is there is no sunk costs. It means any investment necessary in order to enter the market can be fully recouped on exit. After examining the contestability of the market, he concluded that the market is not completely contestable in the Baumol sense at that time. More recently, the market research of OFT also reach a conclusion that many local bus markets in Great Britain are not contestable. Therefore, it is essential to concern the scope of regulation of local bus service.

In term of regulated services, I consider supported services and quality contract schemes.

Many aspects of regulated services in bus markets display a ‘competition for the market’ while deregulated services are characterized by ‘competition in the market’. It means that there is only one incumbent supplier at any given point in time but that supplier must first win a competition to become the incumbent supplier.

3.2.1. Supported services

Supported services are subsidized using public money. These services are deemed socially necessary and may include evening and weekend services on routes which are run commercially during peak times. There is a close link between supported service and commercial service. Services can change from being commercially run to being supported and vice versa.

In 2006/07 Government support for local bus services outside London was £459 million. The amount spent on supported services has more than doubled over the last decade[8] while over the same period the distance run by subsidized services rose about 28 per cent [9].

There is a difference between London and the rest of the country regarding to supported services. As the deregulation of local bus services was introduced in 1986, non-commercial services were then procured by local authorities through competitive tendering process where private bus operators bid for the contract to run a specific route for the specific period. These tendered services comprise 15-20 percent of all services[10]. In London, a fully-tendered regime was introduced from 1985, with all services being progressively opened to competitive tendering over a 15-year phase-in period (completed in 2000)[11]. Competitive tendering have a decisive impact on productivity. The most important direct effects are that the current operator reduces costs or is replaced by a new operators with lower costs. Additionally, indirect effects may arise for operators who are not currently exposed to competition. The threat of future tendering may encourage these operators to increase productivity in order to be competitive when tendering occurs.

Table 1. Cost Impacts from Competitive Tendering

The table show that unit cost reduction in the rest of Great Britain is slightly greater than for London over the same period.

Although competitive tendering is market driven at the time of bidding, given the dominating focus on cost efficiency, it generally provides the wrong set of incentives to do more in line with social obligation or external benefits. The market will not guarantee the optimal level of subsidy as derived from a social surplus maximization model in which profit maximization and external benefits are both taken into account.

3.2.2. Quality Contract Schemes (QCSs)

A QCS is a scheme under which the LTA determines the necessary level and standards of bus provision for the area and grants a particular operator the exclusive right to operate certain services following a competitive tender. They are, in effect, exclusive franchising schemes.

Competitive tendering and QCSs can have complementary roles under a performance-based regime. Normally, QCSs are often used in the situation where the financial gains from re-tendering are small and the exclusive operator is efficient. In fact, QCSs involve a less transparent process with a greater danger of regulatory capture. However, competitive tendering is not immunized from such dangers. Under competitive tendering, the incumbent operator collects extensive market knowledge. This may give the incumbent operator a substantial advantage in re-tendering. Thus, competitive tendering is open to regulatory capture by powerful monopolist providers.

As QCSs depend on partnership relationships, both between individual operators and the regulator and between the set of operators and regulator. It might be some concern that rejecting competitive tendering in favor of quality-based contracts will entrench existing franchised service areas.

3.3. Evaluation of local bus service deregulation

One of the principal arguments for deregulating the British bus industry outside of London was that the competitive market forces that it brought with it would reduce costs, particularly due to higher productivity and lower wage. In fact, the contrasting regulatory regimes in the British bus market where within London, there is a system of regulated competitive tendering, and outside London, the market has been deregulated, have led to many approaches to examine the impacts of local bus service deregulation on competition and welfares.

Firstly, by developing a model of quality competition to determine equilibrium numbers of firms, levels of quality and levels of fares on high density urban routes, J. S. Dodgson and Y. Katsoulacos (1988) [12] used the results to analyse the possible impact of competition, as opposed to that of regulated operation on welfare. Consequently, the impact was proven to depend on two things:

(1) The weight given by the public monopolist to retained profits as opposed to consumer surplus. The higher this weight is, the more likely is it that all consumers benefit in the market equilibrium.

(2) The behavior of total unit costs as bus service quality increases relative to the behaviour of consumers’ willingness to pay for such increases in quality. When total unit costs increase more rapidly than the willingness of high income consumers to pay for quality improvements, it is likely that all consumers will find their welfare reduced after deregulation.

Secondly, economic theory suggests that local bus service deregulation should reduce fares and increase demand if there is an increase in competition. However, following local bus service deregulation in 1986, bus vehicle kilometers increased but passenger journeys fell and bus fares increased in real terms. Between 1985/1986 and 1996/1997 bus fares increased in real terms by an average of 24% and passenger journeys fell by 31%[13] (excluding London). There are two main reasons may lead to this situation: lack of competition or subsidy reduction due to government macroeconomic policy. Figure 2 can interpreter the actual and possible outcomes.

Point A is the actual price/ quantity combination after deregulation and subsidy reduction (Pb2, D2). Point B is the price/ quantity combination that might be observed if the regulated system had continued in operation (Pb1, D1). Point C show the price/ quantity combination that might be observed if subsidy reduction had not occurred; that is, deregulation with subsidy replacement (Pb3, D3). Given the demand curve ABC, the triangle BCD can then be interpreted as the welfare gain from deregulation with subsidy replacement (Figure 2).

By using a wide variety of economics equation combined with the model in Figure 2 including unit root tests, the demand equation and the price-markup equation, Romilly concluded that if subsidy reduction had not occurred, deregulation would have halted the long-term decline in bus patronage in both metropolitan and non-metropolitan areas. Additionally, he also evaluate welfare gains from deregulation for the period 1986-97 (Table 2).

Table 2. Welfare gains from deregulation (£mill)

Source: Romilly (2001).

According to the above results over the period 1986-97, it can be concluded that the positive effects of deregulation per se on fares and passenger journeys are broadly cancelled out by the negative effects of subsidy reduction. However, it is possible that deregulation with subsidy replacement and a system of competitive tendering would yield greater benefits. In his research, Romilly did not explore this possibility.

On the other hand, to examine the effects of deregulation and regulation on local bus services, some researchers take a look at what happens in London and the rest of Great Britain to compare the difference. Based on the models of bus travel demand, Fairhurst and Edwards (1996)[14] constructed econometric models. Using data from the 1970s and early 1980s (prior to the regulatory and organizational reforms), they estimated econometric models to explain bus travel demand. They then used these models to forecast bus travel demand for the years after the regulatory and organisational reforms. They found that these forecasts fitted well with observed bus travel demand in London during the late 1980s and 1990s but did not fit well with observed demand outside of London during this period. Their conclusion was that in London the prior relationships between bus travel demand and population, income, fares etc had been maintained whereas outside of London these relationships had broken down.

Another explanation of the story between subsidy reduction, travel demand trends and regulatory reform of local bus transport was given by Bryan Matthews, Abigail Bristow and Chris Nash [15]. By comparing bus operating costs per vehicle (kilometer), subsidy reduction and passenger journeys on local bus services, these authors providing some important findings as follows:

(1) Bus operating costs per vehicle km in London have reduced dramatically over the period 1986-1998, reaching a minimum in 1995/96, a year after privatisation of London Buses Ltd. While bus operating costs per vehicle km in the English Metropolitan Areas also reduced dramatically over the period, the proportionate size of this reduction is slightly less than that experienced in London. However, this reduction is more remarkable as it was achieved from a much lower starting point, in 1986/7 costs in the metropolitan areas were 65% of costs in London, by 1997/8 costs had fallen to 59% of costs in London.

(2) There is a substantial reductions in government subsidy to local bus services which have taken place in London and in the English Metropolitan Areas following deregulation. The reductions in the English Metropolitan Areas have been relatively gradual, whilst the reductions in London, during the mid-late 1990s in particular, are quite remarkable.

(3) The demand for bus travel was in decline during the 1970s and early 1980s, prior to the regulatory reforms. For example, bus passenger journeys in London fell by almost a third during the 1970s and early 1980s. However, the demand grew slightly during the early 1980s, immediately prior to the regulatory reforms, in both London and in the English Metropolitan Areas. After deregulation, in London, bus passenger journeys grew by 24% between 1985 and 1997/98. In contrast, bus passenger journeys decreased by 38% in the English Metropolitan Areas. Based on the collected evidence, it may be concluded that the competitive tendering system in London has been much more successful than complete deregulation elsewhere in Britain. However it has been agreed that this difference may be explained by the other differences between London and other cities.

Based on their findings, the authors made a conclusion that it is possible that the differences in cost and demand trends are due in part to the different regulatory regimes. However, given the important differences between London and the British Metropolitan Areas in respect of levels of population density, car-ownership, income, parking availability, congestion, availability of complementary rail and underground provision, information provision and integrated ticketing and fares concessions, it has not proved possible to be conclusive on the extent of the influence of the regulatory reforms.

4. Conclusion

The debate on the possible impact of competition in the provision of local bus services has been questionable. So far, deregulation appears to be bringing about substantial reductions in the cost of all operators, and to be increasingly replacing high-cost by lower-cost operators in parts of the tendered market. As a matter of fact, it seems possible that bus deregulation outside London was an improvement on the previous regime although comprehensive tendering in London seems to have been more beneficial. In my opinion, each regulatory regime has its own advantages and disadvantage. The main issue is how to get the best of the regulatory system in which local bus services operate. Therefore, maintaining a continuing control to supported services to prevent monopolisation and developing an effective set of standards for commercial services is what the British government is required to do at this period.