A Quantitative Study of Train Operating Companies Cost and Efficiency Trends 1996 to 2006: Lessons for Future Franchising Policy
A Smith, P Wheat, ITS, University of Leeds, UK
Our paper aims to explore why franchising failed to reduce costs in passenger rail in Britain over the period 1996-2004. We employ state-of-the-art efficiency methods to attribute cost rises to inefficiency, shifts in the frontier and scale effects.
Franchising and competitive tendering has become an important method for introducing competition ?for the market? where competition ?in the market? is considered to be undesirable. In its simplest form, subject to certain assumptions, theory predicts that franchising should result in the tender being awarded to the most efficient operator. The real world is more complex, of course, but in general we can say that franchising should at least put pressure on all bidders to be efficient. The empirical evidence suggests that competitive tendering / franchising has produced substantial cost reductions in a range of contexts, for example, refuse collection and NHS ancillary services, as well as, in the transport sector, London buses (Mackie, Preston and Nash, 1995).
By contrast, despite some reported Train Operating Company (TOC) cost savings during the early years after privatisation (see for example, Affuso, Angeriz and Pollitt (2002) and Cowie (2005)), TOC costs have increased very sharply since the Hatfield accident. Nash and Smith (2006) find that TOC own costs (that is, excluding rolling stock costs and access charges) increased by almost 50% between 1999/00 and 2003/04 (or nearly 40% on a cost per train km basis). As a result, subsidies to passenger train operators increased sharply over this period.
Our paper aims to explore why franchising failed to bring costs down in the passenger rail sector in Britain over the period 1996-2004. We employ state-of-the-art efficiency methods to attribute cost rises to inefficiency effects between TOCs, shifts in the production possibilities frontier over time and changes resulting from scale effects.
We build on previous work in this area through both methodological and data improvements. While a range of methods have been employed across a limited number of previous studies, it is unclear whether differences in results are true differences or simply due to the statistical method employed. For example it is well acknowledged (Farsi, Filippini, Greene (2005) Journal of Regulatory Economics) that utilising the fixed effects approach may over state the true efficiency effects since the dummy variables capture all time invariant characteristics. In our paper we present several models estimated using different parametric efficiency techniques utilising the same data set. This allows us to investigate the extent to which the econometric method impacts on the results of the analysis. We plan to estimate panel models including fixed and random effects, as well as stochastic frontier models (SFA). SFA methods decompose the error term of the cost function into a symmetric random error term capturing uncontrollable factors and a one sided error which captures firm specific inefficiency and are estimated using the maximum likelihood principle.
Our data set is also an advance over that employed in other studies. We utilise data from 1996/97 to 2005/06 for the 25 TOCs in Great Britain. Studies to date have only considered data up to 1999/2000. There is great policy interest in extending the analysis forward given the cost explosion in railways and specifically in train operations. We would seek to explore issues such as can we measure the cost of improved quality over the period? Is the push towards fewer, larger franchises likely to reduce costs given the cost structure? To what extent has cost rises been industry-wide versus TOC specific?
Finally, we improve on data by utilising not just data from TOC accounts as in previous studies, but also access and penalty payments to/from Network Rail/Railtrack which, once subtracted from TOC costs give us a much more reliable measure of the costs directly under control of the TOCs. Identifying TOC own costs is essential to understanding the true drivers of TOC cost increases versus those which have been imposed on the TOCs by other areas of the industry.
Association for European Transport