In the first of a new series of articles on rail fares, Andrew Meaney, Managing Consultant at Oxera, offers his thoughts on how the government should approach its forthcoming Fares Review.

Arguably, rail fares policy is currently a useful lever at the government’s disposal for rebalancing funding between the taxpayer and the passenger. However, there are many other potential objectives that the government might seek to meet by restricting train operators’ pricing freedom, and many potential forms of regulation. Good practice would suggest that the forthcoming Fares Review would start with a clear statement of policy objectives, and would then design fares policy and regulation accordingly.

The passenger rail market in Great Britain is going through considerable change. Passengers are awash with information, enabling them to select from a much wider set of journey opportunities at their disposal – in terms of two general aspects: what alternative destinations can offer them, how to get there, and which travel product to use to get there; and the purchasing platform to use to make their purchase. This wealth of information, available for all modes of transport, means that rail has to price much more keenly and proactively in order to retain or grow its market share.

This combination of more products and more information (perhaps together with people searching for value in a post-recession environment, and factors such as video conferencing enabling people not to travel at all) seems to be behind the higher fare elasticities – a measure of how sensitive passenger demand is to changes in fares – found by Oxera’s research for the industry over the past four years or so. This increased sensitivity is likely to make the convenient lever of fares policy in rebalancing funding towards the user much less effective.

In addition, there are signs that, nearly 30 years after privatisation, the rail market in Great Britain will reach a ‘break even’ point. The latest Initial Industry Plan for England and Wales expects net subsidy to fall to around £1bn by 2018/19, down from around £3bn in 2013/14. If revenues continue to grow, and costs remain static or fall, there is every chance that net subsidy will be zero early in the next decade.

Policy-makers have learned from economists that there may be a rationale for regulating a market when there is clear evidence of ‘market failure’ – indeed, prime minister David Cameron, speaking on The Andrew Marr Show, BBC1, on January 8, said that there is a market failure in executive pay that gives him reason to intervene in that aspect of the economy. Clearly, government is currently intervening in the rail market in a big way – providing subsidy, setting high level outputs and passenger service patterns, etc. This is driven by what economists call the ‘positive externalities’ of rail services – such as reducing road congestion and accidents, a lower carbon footprint, and delivering economic growth – that would not be maximised were it left to the market to provide rail services.

However, as price elasticities rise (which suggests that rail’s ‘market power’ is diminishing, in certain markets at least), and net subsidy declines towards zero (which arguably lessens the need for government intervention in the market, relative to the network requiring £6.8bn in subsidy in 2009/10 prices as recently as 2006/07), the rationale for fares policy and fares regulation needs to become more transparent. At a minimum, the forthcoming Fares Review should start with a clear statement of policy objectives, in the context of the current market, together with what is expected to happen over the next decade or so.

Once clear objectives are in place, the mechanism by which fares are regulated can be optimised. This may be an opportunity for the form of regulation to be revised considerably. Fares regulation might, for example, encourage demand management at peak times by pricing on a ‘time slice’ basis (within an overall consumer protection mandate), and the availability of reasonably priced walk-up tickets for the leisure market. Each of these possibilities would be achievable with technology that is currently available, but not yet widely adopted on Britain’s railways.

Instead, the current system seems to incentivise demand management only with the bluntest of instruments (raising season-ticket prices in accordance with national fares policy), and the retention of under-priced ‘Off-peak’ (a.k.a. Saver) returns. The latter causes bunching of demand at the edge of the peak periods (as people delay their morning departure to catch the cheaper train, for example), and severely constrains the ability of operators to use airline-style pricing according to capacity (even on routes where they are competing against airlines or coach operators, which benefit from considerably more pricing flexibility according to demand conditions).

It follows that the current set-up leads to operators incurring cost to increase capacity (by lengthening trains and/or upgrading infrastructure) faster than they need to in order to cope with increasing demand, relative to the situation in which they could use fares to match demand to capacity. Further capacity is needed to manage the artificial peak arising from the regulation of off-peak products, which also prevents operators from maximising the value of their services, reducing industry revenues.

I would, therefore, expect the forthcoming Fares Review to apply two steps:

  • Define a set of sustainable fares policy objectives. This will include a clear rationale for government intervention as the industry develops over the next decade. The objectives could range from consumer protection against excessive pricing, through managing load factors, to encouraging modal shift or cost reflectivity.
  • Optimise fares regulation in accordance with these objectives. The first step will be to define the scope (in terms of products and geographies) of regulation. This could be achieved (as happens in other regulated sectors, such as post and communications) using economic tests to assess where operators have market power, with regulation then focused purely on these areas. The government could then overlay its wider objectives, expanding the scope of regulation to ensure that these are also met – for example, by capping prices of walk-up tickets. Whether government needs to retain the ability to change the level of regulated fares in this environment could subsequently be clarified.

The key here is transparency of objectives, together with economic evidence of the costs and benefits of alternative forms of regulation in meeting those objectives. In today’s political climate, ensuring that there are few losers, and plenty of winners, is also probably a wise element of the assessment.

Without such clarity of approach, the current Fares Review is likely to descend into a fairly trivial exercise, missing the opportunity to unlock considerable potential for cost savings and revenue increases, while improving the passenger experience.

Rail fares at a cross roads?

Andrew Meaney of Oxera will be among the speakers at a special seminar on the issue of rail fares next month. Regulation to Relaxation: Rail Fares at a Cross Roads? will take place in central London on February 23.

Sir Roy McNulty has speculated on the potential benefit of a relaxation of fares box controls, leaving franchise operators free to apply different types of fare offers without necessarily damaging consumer support and usage. There is a well supported view that greater flexibility may lead to both increases in ridership and gross revenue. However, there are equally strong views against such a relaxation from consumer groups.

This participatory seminar, organised by rail experts First Class Partnerships in partnership with Waterfront Conference Company and Passenger Transport, will explore the potential outcomes of fares relaxation and how the process could be effectively managed. It will address the possibilities for a change in fares policy, and what kind of changes would be acceptable to all parties affected?

The seminar will hear presentations from David Mapp, commercial director at the Association of Train Operating Companies, Michael Beswick, director – rail policy, ORR at the Office of Rail Regulation and Mike Hewitson, head of policy at Passenger Focus. There will also be expert views from Mike Jones, director, Hull Trains, John Nelson, chairman of First Class Partnerships, John Segal director, rail, MVA Consultancy and Michael Schabas, an advisor to World Bank.

Passenger Transport readers can claim a 10% discount on attendance fees and sponsorship packages (to book online visit thewaterfront.co.uk and quote the discount code PT139-140 in the online registration form).

If you’re interested in sponsoring or exhibiting at this event, email carrieswift@thewaterfront.co.uk or call 020 7787 1210 for details.

A further First Class Partnerships seminar, Rail Industry Reform, will be held at Osborne Clarke in central London on February 28. Visit thewaterfront.co.uk for details.

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