Reports:
Bus subsidy simulation study
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Executive Summary
1: Introduction
2: First Round of Interviews with Operators and Local Authorities / PTEs
2.1: Interview Method
2.2: Findings from the Interviews
3: The Bus Simulation Model
3.1: Background and Earlier Work
3.2: The Model Developed for the Present Study
3.3: The Demand Model
3.3.1 Overview
3.3.2 Functional Form of the Demand Model
3.3.3 Parameter Estimation
3.3.4 Demand Model Calibration
3.4: The Cost Model
3.4.1 Introduction
3.4.2 Current Cost Drivers
3.4.3 Costs to Run the Model Timetable
3.4.4 Additional Elements in the Cost Model
3.5: Profitability Calculation
3.6: The Optimisation Model
4: Results of the Modelling Work
4.1: Introduction
4.2: The Routes Examined
4.3: The "Day 1" Impact on Profits
4.4: How Will the Operators Respond?
4.4.1 Introduction
4.4.2 No Specific Constraints
4.4.3 Prices Constrained at their Present Level
4.4.4 Frequencies Constrained at their Present Level
4.5: How We Believe Operators Will Respond in Practice
4.5.1 Introduction
4.5.2 The Impact of Cross-Subsidy
4.5.3 Will the Predicted Fall in Prices Materialise?
4.5.4 The Impact of Perceived Changes in the Likelihood of Entry
4.6: Overall Conclusion of Simulation Modelling
5: Second Round of Interviews
5.1: Introduction
5.2: Interview Method and Response
5.3: Interview Findings
6: Conclusions
Appendix A: Interview Topic Guide for Bus Operators
Appendix B: Interview Topic Guide for Local Authorities/PTEs
Appendix C: Data Request from Bus Operators
Appendix D: Profit Maximising Positions
Executive Summary
This report describes work undertaken on behalf of the Commission for Integrated
Transport (CfIT) to simulate the reaction of bus operators to a potential change in
the subsidy regime from Fuel Duty Rebate (FDR) to an Incentive Per Passenger
(IPP). The simulation study was undertaken by FaberMaunsell, in conjunction with
NERA and the Institute for Transport Studies (ITS) at the University of Leeds.
Previous Work
The proposal for a shift from FDR to IPP emanated from an earlier CfIT study
undertaken by L.E.K. Consulting (LEK), in conjunction with ITS and the Transport
Studies Unit at the University of Oxford. The LEK study was entitled "Obtaining
Best Value for Public Subsidy for the Bus Industry" and had the principal objectives
of:
- increasing bus patronage;
- encouraging modal shift to buses which leads to congestion relief; and
- improving social inclusion for those who are socially excluded due to transport
issues.
The summary recommendations of the LEK report make it clear that the move from
FDR to IPP is primarily aimed at increasing bus patronage, and that additional
funding (referred to in this report as the 'safety net') would be required in rural and
inter-urban areas to counteract any decline in subsidy on routes or services in
those areas resulting from the change.
The encouragement of modal shift and improvement of social inclusion were based
on a collection of other initiatives, including QBPs and Park & Ride schemes and
improved concessionary fares and more secured routes in rural areas.
This Study
Following the LEK study, CfIT wished to gain a more detailed understanding of the
effect that the subsidy change would have on service patterns and commissioned
the current study which involved detailed discussions with a small number of
operators and local authorities, along with a modelling exercise to estimate the
effects of the change on particular routes. In particular, the objectives of the
current study were:
- to establish the impact of the change from FDR to IPP and predict the possible
reaction from bus operators and local authorities in terms of changes in
service patterns by way of a modelling approach; and
- to identify difficulties currently experienced by bus operators and local
authorities and investigate the extent to which the identified barriers would
impact upon the rollout of an IPP system.
The study was based on interviews with bus operators and local authorities in a
Metropolitan area and a Shire area before and after a modelling exercise, with the
first round of interviews exploring initial reactions as well as requesting data for use
with the model. Operators were asked to provide data on operations, passenger
volumes, revenues, costs and profits for a selection of specific routes they
considered representative of the route categories being studied. The second round
of interviews then allowed the findings from the modelling work to be put to the
operators, partly to validate the modelling work and to probe further for their likely
reactions. The second round of interviews with local authorities concentrated on
the likely effects of the changes in route profitability on tendered services and on
social inclusion.
The interviews were conducted with representatives from the transport authority
and two bus operators in each case study area. These operators covered 90% of
the services in the Met area and 99% of services in the Shire area.
The Typical Routes
A total of nine routes were examined as part of the study. These were:
- Two busy profitable urban routes with frequencies of between six and eight
buses per hour (Busy Urban 1 and 2);
- A profitable urban route with a bus every 20 minutes (Medium Urban);
- A marginal urban route with a bus every 12 minutes. This service was
unprofitable in the period for which the operator supplied the data, though the
route breaks even in some periods of the year (Marginal Urban);
- Two profitable interurban routes with around two buses per hour; both with a
somewhat more rural part at one end of the route (Busy Interurban 1 and 2);
- A marginally profitable interurban route with two buses per hour; running
beyond the bus station through several areas of the town at one end of the
route. (Marginal Interurban);
- A loss-making (not covering its direct costs) unsubsidised interurban route
with predominantly end-to-end traffic and an hourly frequency (Loss-Making
Interurban); and
- A profitable (when taking tendered revenue into account) route of a more rural
nature between two medium-sized towns and little in between (Rural).
The routes were selected by asking the operators for typical examples of the route
types under consideration. We have not been in a position to verify whether these
routes can indeed be regarded as typical examples, though we have no reason to
believe that they would be atypical. We note that none of the operators had any
difficulty with suggesting examples of "typical" routes on their networks.
All routes are commercial, though some are in part tendered. We have not
analysed routes that are entirely tendered since on such routes, operators will have
little or no freedom to set fares, service and quality levels. The results of our
analysis suggest though that entirely tendered services will normally become more
loss-making when FDR is replaced by IPP, so that tender prices for such routes
can be expected to increase.
The Model
The simulation exercise is required to represent all the short and long term
responses to changes in the subsidy regime. In the deregulated bus market
operators seek to maximise their profits subject to constraints. Consequently, it
was necessary to build a model that replicated the decision making process of bus
operators.
The simulation model has been built at the level of individual routes, since
operators' responses could be expected to differ between routes.
The model predicts the impact of the change in subsidy system on:
- route profitability; and
- the operator's profit-maximising decisions on a particular route.
The model can be set up for any time period; in practice the operators have
supplied data for four-week periods.
In order to be able to simulate the combination of fares and service levels that
would maximise profits for the operator, it was necessary to estimate both a
demand and a cost function.
The demand model was driven by price, frequency of service and a variable
representing quality. The inclusion of quality reflects the LEK view that introducing
IPP will result in patronage growth largely as a result of quality improvements
introduced by the operators. The quality variable was defined at three levels, as
follows:
- level 1: a basic bus service without specific quality features;
- level 2: a bus service with low-floor buses, driver training and CCTV; and
- level 3: as level 2, plus good shelters with real-time information and CCTV.
Currently, it tends to be the local authority that is responsible for quality measures
in regard to shelters, so the question could be asked whether operators engage
themselves in providing quality improvements by investing in infrastructure. In view
of the fact that on a number of routes in our sample, quality level 2 had already
been achieved, it was however necessary also to introduce a higher quality level to
see if the proposed change in subsidy system would provide incentives to these
operators to invest more in quality than they currently do.
The cost model has been based on the actual costs on the modelled bus routes on
the basis of CIPFA principles. These principles, which are widely used in the bus
industry, imply that costs are allocated to one of the following three cost drivers:
- vehicle hours;
- vehicle kilometres; or
- peak vehicle requirement.
Fuel costs were treated separately since current net fuel cost levels would no
longer be correct if FDR were to be abolished. Fuel costs were therefore made
dependent on the level of FDR: if this is reduced or abolished, current fuel costs
and the cost per vehicle kilometre are automatically adjusted upwards.
The cost function also included an explicit representation of quality, which as one of
the three key demand variables was essential to have represented in a realistic
way. In addition, the cost function included a relief cost function to represent the
fact that the operator is required to run relief buses if services become
overcrowded.
The optimisation model maximises profits by manipulating the price, buses per hour
and quality variables, subject to a number of user defined constraints. There are
four possibilities:
- Maximise profit. In this case, it is possible, but not mandatory, to impose the
constraint that the frequency should be an integer. This constraint can be
imposed because in the vast majority of cases, the frequency per hour that
operators run is indeed an integer. However, it is not necessary to impose this
constraint, and allowing frequency to vary continuously allows us to evaluate
how the change in subsidy system will affect marginal incentives to increase
or decrease frequency;
- Maximise profit subject to bus frequency equal to a certain value. With this
option, the desired frequency can be entered and the model optimises by
holding frequency constant and manipulating just the other two variables. This
option is very important if the operator runs more buses than it otherwise
would have done to avoid profitable gaps into which competitors might enter.
It can also be used to evaluate possible strategies where the frequency is not
an integer, e.g. one buses per two hours (in which case the value to be
entered is 0.5);
- Maximise profit subject to price equal to a certain value. This option holds
price constant and manipulates frequency and quality. This option is useful if
the operator chooses to set prices below profit-maximising levels, again
possibly to deter entry or for political reasons;
- Maximise profit subject to quality equal to a certain value. With this option,
only fare and frequency are manipulated. This option can be used if there is
no scope for changing the quality level offered, for example if new buses have
just been introduced on the route which are not going to be modified in the
short or medium term.
Modelling Results
The impacts of the proposed change in subsidy system can be thought of as
occurring in a two-stage process:
- Initially, the change in subsidy system will have an impact on route
profitability, with costs increasing due to the loss of FDR and revenues
increasing as a result of the new per-passenger subsidy. We refer to this as
the "Day 1" impact. This is the direct impact of the subsidy change on a
route's profitability when the operators do not change their behaviour;
- However, the operator may review the route and adjust prices, service and/or
quality levels on it in response to the change in subsidy and in response to the
changes in incentives resulting from the change in the subsidy system. Thus
it should be possible to increase profits from the levels achieved as a result of
the "Day 1" changes by changing the service's fare, frequency and/or quality
level. In addition, there may be a need for service cuts if route profits have
fallen or there may be need to adjust frequency levels in response to a
perceived increase in the threat of entry by other operators. We refer to this
as the "impact from optimising". These adjustments may only take place
after the subsidy system has been changed, though it is possible that
operators might make some adjustments in anticipation of subsidy changes
that they know are going to take place.
It is important to note that the proposed change in the subsidy system will only
result in a change in the number of bus passengers if the operator actually changes
his behaviour. If the subsidy change results in a large change in route profits but
the operator nevertheless chooses not to react (for example because the operator
accepts a degree of cross-subsidy in its system), then there will be no impact on
patronage whatsoever.
As expected, it is mainly the urban routes that gain and the interurban/rural routes
that lose (before allowing for the impact of the safety net) from a move from FDR to
IPP. One of the busy urban routes in fact achieves a very substantial gain,
whereas by contrast the other busy urban route (which has a high frequency level
relative to the number of passengers carried) gains only marginally. The medium
urban route also gains, but the marginal urban route loses. The already existing
losses on this route increase by almost 40 per cent. All of the interurban and rural
routes are worse off as well, with profits on these routes falling by between 6 and
25 per cent, and in one case the already substantial losses almost doubling. We
note that there are no routes that were profitable and become loss-making,
although the profit losses on the interurban and rural routes may mean that, without
the safety net, the routes would no longer meet minimum profit targets. However
the loss of profit on the interurban/rural routes would be offset if the safety net was
applied as we understand was envisaged in the LEK work.
Whereas the above result that few routes gain and many lose might appear to be a
result of the combination of routes that we have selected, we would expect that this
result would in fact also hold in general. Busy urban routes carry very high
passenger volumes and in combination with the short average journey distance on
these routes, they will gain disproportionately from a flat IPP subsidy. Routes that
are more dependent on FDR, such as interurban and rural routes, will tend to have
lower passenger volumes and a longer average journey length, both of which
adversely affect them in the context of a flat per-passenger subsidy. The marginal
urban route in our sample is also worse off. Our prediction is therefore that a
revenue-neutral change in subsidy system would result in the majority of routes in
the country being worse off, with most of the subsidy being reallocated to a
relatively small number of busy urban routes that will see their profits increase
disproportionately.
The simulation modelling has shown the initial impact of the switch in subsidy
system from FDR to IPP. This shows how, in the revenue-neutral[1] case (without
the safety net), most of the routes in our sample lose, including two urban routes.
Two other urban routes gain, one of them disproportionately. When the safety net
is provided, in the manner envisaged by LEK, the inter-urban and rural routes are
protected, and only the less busy urban routes lose.
After looking at the immediate effect of the subsidy switch, we then consider the
incentive effects of the switch. It must be noted that these are the same
irrespective of the existence or size of the safety netprovided that the operator
continues to run the service. Identification of these incentive effects involves
modelling how the switch in subsidy affects bus operators' behaviour. We do this
under three circumstances: with fare, frequency and service quality all free to vary;
with fare fixed; and with frequency fixed. When all aspects of bus operators'
behaviour change, fares will fall, and this will increase demand. But frequency also
falls on all but two of the urban routes, and the impact of this on patronage works in
the opposite direction to the fares reduction, causing demand to fall on three of the
routes (and causing it to be unchanged on another one of the routes). When fares
are sticky the beneficial effect on patronage of fares reduction is lost - frequency
rises on three of the urban routes but falls on all other routes. Although there are
some quality improvements, bus patronage falls on all interurban and rural routes,
as well as on one urban route. On the other urban routes, patronage still rises but
by less than in the previous scenario. However, where frequency is fixed,
patronage rises on all routes as a consequence of reductions in fares, reinforced by
an improvement in quality. A situation where frequency is fixed but fares fall
appears to be the best situation - but controlling frequency in practice may be
difficult to achieve - the danger is that while some operators may not make small
reductions in frequency intervals, some others may make significant reductions.
There are a number of additional factors that may influence the way in which bus
operators may react to a change in subsidy. These include the extent to which
operators are prepared to accept an increasing degree of cross-subsidy, the extent
to which fares will be reduced, and the impact of changes in the perceived threat of
entry onto certain routes. Entry by small competitors may be a threat on the
busiest routes, though it is less likely to be so on thinly-served routes. Although
fares may be sticky in a downward-direction, operators may be prepared to defer
increases where there are incentive effects to do so. Although some operators
might be willing to accept an increasing degree of cross-subsidy to preserve their
network and deter competition, we think it more likely that they would instead wish
to seek profit opportunities, especially in the longer term.
We have aggregated our results to national level (England excluding London) using
data supplied by LEK from their bus industry database. Our estimate of overall bus
passenger growth is 4.7 per cent, or 114 million additional passenger journeys.
This is somewhat lower than the comparable LEK long run estimate, reflecting our
more cautious treatment of quality improvements, based on interviews with
operators.
We believe that between 20 and 40 per cent of these additional trips will transfer
from car, representing the transfer of 23 to 46 million car trips. Whilst this number
is clearly very significant, it represents an average a 0.08 to 0.16 per cent fall in car
trips. In urban areas the transfer would be greater, representing a 0.16 to 0.32 per
cent fall in car trips.
Conclusions
The conclusions presented are drawn from a combination of interviews with
operators and transport authorities and from analytical modelling based on a
selection of routes in two specific areas. The interviews inevitably contain a degree
of 'inertia' and of 'policy response bias' whereas the analytical modelling inevitably
omits some of the wider network and political acceptability influences that may
create a degree of inertia in practice.
- Operators of busy urban routes were able to quote examples of investment in
quality leading to patronage increases that justified increased frequencies,
creating the virtuous circle that is being sought.
- As anticipated in the LEK report, the proposed change in the subsidy system
is expected to be beneficial for the operators of busy urban routes, whereas
marginal urban, inter-urban and rural routes, in general, are expected to be
worse off, and would require a safety net if they are to continue to be
operated.
- It appears that the gains will be enjoyed by a relatively small number of route
types in urban areas that may gain disproportionately, with the majority of
route types actually being worse off and in need of a safety net, as proposed
by LEK.
- The busy urban routes carry a substantial proportion of all patronage, such
that an overall increase of almost 5 per cent could be expected when the
results are aggregated to national level.
- The move away from FDR might be expected to encourage greater fuel
efficiency in the longer term, although it was pointed out that the higher quality
buses tend to be heavier, such that the achievement of improved fuel
efficiency may be difficult in practice.
- On busy urban routes a move from FDR to IPP produces an incentive to
increase patronage, mainly as a result of the impact of lower fares, but also (to
a lesser degree) due to incentives to provide higher frequency and quality.
- The incentive to higher frequency and quality on busy urban routes may
produce some transfer from car in the most congested areas, although we
note that the cross-elasticities between car and bus are very low and a
substantial improvement in the product offer would be required to effect a
significant modal shift. We estimate that the almost 5 per cent increase in
patronage would produce a reduction in car trips of less than 0.5 per cent.
- Local authorities felt that there were benefits of increased clarity between
commercial and tendered services. They also made the point that it would be
important to ensure that additional profits on busy routes (or on routes where
the LA implemented infrastructure improvements), would be ploughed back
into improved services on those routes or into longer hours of 'commercial
service'.
- On inter-urban and rural routes, the incentive of the change[3] is generally to
reduce frequency (difficult to achieve in practice on routes which are already
infrequent), but also to lower fares, which in combination result in relatively
small change (decrease or increase, depending on the specific circumstances
of the individual routes) in patronage.
- On inter-urban and rural routes, whilst passenger numbers are unlikely to be
greatly changed, if the safety net is not provided then the profitability of routes
will be seriously affected, and this may lead to some deregistering of services
and increased social exclusion.
- Major changes to network configuration and maintenance of routes, are not
anticipated in the short term, since operators tend to cross subsidise and take
a full network approach (in the particular operating area) to discourage
competition.
- Local authorities believe that there may be an immediate move to maintain
overall revenues at their previous levels, and in the absence of a safety net
this will inevitably result in some withdrawals of service, particularly in rural
areas. This is reinforced by a perception that some operators may see the
policy change as an opportunity to re-organise and streamline their operations
particularly with respect to the lightly trafficked routes, either by curtailment of
route lengths or of hours.
- We believe it to be very unlikely that the introduction of IPP will result in an
actual overnight fall in fares. In our view, fares will display a degree of
"stickiness" or rigidity and will not actually come down in absolute terms.
Rather, a number of operators have suggested that they may want to
moderate or defer a fare increase.
- The implication of applying the safety net only to support interurban and rural
services, as proposed by LEK, is that some marginal urban services will be
withdrawn, which could impact on social inclusion in urban areas, although
operators focus on networks may mitigate this.
- Both operators and local authorities have raised concerns with respect to
practical issues and the costs of the burden of auditing the figures and pointed
out the importance of auditing in marginalising the impact of possible
fraudulent behaviour by some operators.
- A number of 'gaming' approaches were discussed with operators and local
authorities and, whilst it was concluded that there could be considerable scope
for beating the system, it was thought that most of them could be countered
through auditing.
- Smartcards are seen as the primary method of reducing the administrative
and auditing burden. However, operators and authorities have considerably
different views with respect to the timescale involved in the widespread use of
Smartcards and the business case for this technology.
1: Revenue-neutral in this context refers to the Day 1 position, in which FDR is simply switched to IPP
on the basis of the patronage at that time.
2: This is because we are looking at the
marginal effects on profitability of changes in fare, frequency
and quality for a given service. The safety net is the equivalent of a block subsidy based on the loss
in profits due to the Day 1 subsidy change, and is assumed to be independent of the operator's
responses to changed incentives to maximise profits.
3: irrespective of the existence or size of the safety net provided that the route is still operated.
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