Local bus services The OFT's reasons for making a market investigation reference to the Competition Commission January 2010 OFT1158 © Crown copyright 2010 This publication (excluding the OFT logo) may be reproduced free of charge in any format or medium provided that it is reproduced accurately and not used in a misleading context. The material must be acknowledged as crown copyright and the title of the publication specified. CONTENTS Chapter/Annexe Page 1 Executive summary 4 2 Overview 10 3 Market definition 29 4 Findings 42 5 Decision on a Reference 93 A Terms of reference 106 B Classification of bus operators 107 C Methodology 114 D Legal framework 118 E Econometric Analysis 125 F Market structure and fleet quality 258 G Analysis of head to head competition for supported services 270 1 EXECUTIVE SUMMARY 1.1 In August 2009 the OFT consulted on the findings from our market study into local bus services. We suggested that the market was not working well and consulted on a proposal to make a Market Investigation Reference to the Competition Commission. 1.2 Our market study looked at the extent to which competition in the provision of local bus services in the UK, excluding Northern Ireland (NI) and London, delivers quality and value both for bus users and for the level of public subsidy which the operators receive. 1.3 This is a large industry, with recent commercial revenues of approximately £2.4 billion. Local bus services receive a large amount of public funding. In 2006/07 Government support for supported bus services and spending on concessionary fares in the UK, excluding NI and London, amounted to £1.2 billion, which represents almost a third of the total revenue of bus operators. 1.4 After consulting on our findings, we remain of the view that the evidence suggests, in many local areas, current competitive pressures may be insufficient to achieve best value outcomes for both bus users and tax payers. 1.5 The OFT has decided to make a Market Investigation Reference to the Competition Commission. Findings 1.6 Our evidence indicates that, notwithstanding the constraints which may be placed upon bus operators by cars and other travel options, limited competition between bus operators tends to result in higher prices, our conservative estimate is nine per cent higher, and lower quality, for bus users. The major bus operators commissioned a statistical review of our work which they claim undermines our finding. While we disagree, and believe our results are sound, we consider that the Competition Commission is now best placed to carry out further detailed analysis. 1.7 The major bus companies have argued strongly that they face significant constraints from other modes of transport and, in this sense, they argue, they face a great deal of competition. We consider that this argument is OFT1158 | 4 inconsistent with both our analysis and a large number of independent studies. That said, we do acknowledge that there well may be differences in competitive conditions in different local areas. Our analysis did include controls for these differences but of course we expect that the Competition Commission may wish to carry out more detailed work on this point. 1.8 In our consultation, we set out evidence which suggested that competition for contracts for supported services may be weak in some local areas and that this may have been a contributing factor to the increase in the cost to the tax payer of providing supported bus services over the last ten years. In particular, we noted that the overall level of bids for contracts was low in many areas and that the total level of support had risen substantially in recent years. We also noted that the cost of like for like services had increased significantly in real terms. 1.9 A number of respondents disagreed with the last of these findings arguing that the cost data we had used to calculate the real cost increase in like for like services was flawed. We note that the evidence regarding a low level of bids, combined with the data about the total spending on supported services is, in itself, grounds for concern. We accept that there are issues that make it difficult to precisely estimate the scale of real terms increases in the cost of like for like services, but we continue to believe that the evidence points to potentially significant increases. We also note that a similar finding has been made by other researchers. 1.10 Several parties, in response to our consultation, questioned the proportionality of a reference. They argued that current work by Department for Transport, or the available powers to Local Transport Authorities (LTAs), Traffic Commissioners and OFT could adequately deal with the concerns raised in our consultation. They also argued that a reference to the Competition Commission would delay improvements and investment provided for by the Local Transport Act 2008 (LTA 2008). OFT1158 | 5 1.11 We disagree that, without further work, the concerns raised in the consultation document can be adequately addressed now. We believe that the Competition Commission is best placed to carry out the necessary further detailed investigation which should reveal the nature of the underlying causes of the problematic features of this market and, if necessary, take an in-depth look at possible remedies. 1.12 The OFT has reasonable grounds to suspect that a number of features prevent, restrict or distort competition for local bus services in the UK, excluding London and Northern Ireland and these are summarised below. Structural features which the OFT reasonably suspects adversely affect competition 1.13 The industry has tended to a situation in which many routes, especially non-corridor routes,1 are served only by a single operator. This may be an inevitable feature of the available demand on these routes and, if so, would not necessarily be a feature adversely affecting competition. In this case, however, given the wider context of regional and local area concentration we suspect that it is such a feature. 1.14 Consolidation of depot ownership has meant that large regions tend to become dominated by a particular operator that supplies most of the services. The pattern of depot ownership at a regional level may be a contributing factor to the concentration in service provision at a local level. It may be that regional consolidation in depot ownership makes smaller operators that come up for sale unattractive to any purchaser other than the dominant local operator as they are only a good regional fit for that operator. 1.15 The way the concessionary fare regime works may distort the market by creating an incentive for bus operators to raise fares. The concessionary fares regime may, in some areas, give operators an incentive to increase 1 Corridor routes refer to routes along major road corridors carrying high volumes of traffic, often serving gyratory or radial roads for a town or city. OFT1158 | 6 some commercial fares due to the effect it has on the price sensitivity of the overall customer base and also the effect it can have on their cost base. Conduct of firms which the OFT reasonably suspects adversely affects competition 1.16 We have frequently received allegations of targeted competition of the kind that is designed to eliminate competitors without providing any long term benefit to consumers. We cannot currently say if any of the behaviour has been predatory other than in the two cases we have investigated. Nevertheless, we have reasonable grounds to suspect that this sort of competition, taken in the context that many smaller operators cite it as a key reason for not expanding services into areas where larger operators have services, is conduct that prevents, restricts or distorts competition. 1.17 Incumbent bus operators with a well developed network may have little incentive to enter into multi-ticketing arrangements with smaller rivals as the benefits to the rival were greater than the benefits to the incumbent. The OFT considers that it has reasonable grounds to suspect that this is conduct which may prevent, restrict or distort competition. OFT1158 | 7 Conduct of consumers which the OFT reasonably suspects adversely affects competition 1.18 Bus users are most likely to get on the first bus that appears at the bus stop going to the destination they want – this has an impact on how bus operators position their services when in competition with each other. This feature may encourage exclusionary behaviour by making 'over- bussing' a particularly effective strategy to deter potential entrants. We consider that consumer behaviour may have facilitated some exclusionary practices by bus operators and as such is a feature of local bus markets that prevents, restricts or distorts competition. Combination of features which the OFT reasonably suspects adversely affects competition 1.19 The manner in which some LTAs manage competition when combined with the concentration in many local markets may combine to prevent, restrict or distort competition. 1.20 In particular, we are concerned about areas that receive low numbers of bids for tendered services. We have seen examples in both large (West Yorkshire) and small (some parts of rural Essex) geographic areas. Issues here cover both the way some local authorities design tender exercises and more structural issues such as where route and network design may encourage gaming of the tender system. Performance information indicating that competition may be adversely affected 1.21 We have estimated that in areas where only one of the large national groups offer services, fares for commercial services are nine per cent higher than in areas where two or more of the national groups operate.