The Economics of London Bus Tendering By David Kennedy Submitted for the degree of PhD The London School of Economics and Political Science January 1996 UMI Number: U482971 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction is dependent upon the quality of the copy submitted. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if material had to be removed, a note will indicate the deletion. Disscrrlation Publishing UMI U482971 Published by ProQuest LLC 2014. Copyright in the Dissertation held by the Author. Microform Edition © ProQuest LLC. All rights reserved. This work is protected against unauthorized copying under Title 17, United States Code. ProQuest LLC 789 East Eisenhower Parkway P.O. Box 1346 Ann Arbor, Ml 48106-1346 Tf4£-5 S F rOLITiCAL ’' o S lOSSif^iZ ABSTRACT Following a period of rising costs, competitive tendering was introduced to the London bus industry in 1984. This thesis is an economic analysis of the impact of tendering on London bus services. Chapter 1 states the aims and objectives of the thesis in the context of the economics literature. The chapter is divided into two sections. In section 1 the literature is drawn upon to provide an economic interpretation of the state of the London bus industry prior to the introduction of tendering, and to provide an economic context for the introduction of tendering. In section 2 literature relating to the design of a tendering process is summarised. The focus is on the auction aspect of the tendering process and some important dimensions of contract specification. The impact of tendering on costs is analysed in chapter 2. Three questions are asked: What is the cost structure of the competitive London bus industry? Is there any evidence of strategic bidding behaviour as predicted by the auction theory literature? What level of cost saving can be attributed to tendering? The analysis is based on the full set of bid data from London bus tendering over the period 1985-1993 and is econometric in nature. The results are: there is no statistically significant difference in costs of operation between public and private sector operators under competition; bidding behaviour conforms to some features predicted by theoretical models; the estimated cost saving from tendering is 20%. Chapter 3 evaluates the impact of tendering on the demand for bus travel in London. The relationship between demand and service quality is estimated, gains to tendering are attributed in accordance with the increased service quality due to tendering. A statistically significant relationship between demand and service quality is found. The lowest estimate of revenue gained due to tendering is £9.6 million over the period 1987-1992 in 1992 prices. Chapter 4 estimates the welfare gain due to tendering, defined as the sum of changes in producer and consumer surplus due to tendering. The estimated welfare gain due to tendering is between £90 and £380 million over the period 1987-1992 in 1992 prices. An appendix to this chapter analyses the relationship between welfare and the type of contract upon which tendering is based. 2 It is argued that a cost contract is preferable to a bottom line contract. Chapter 5 is based on an in depth series of interviews with key actors in the London bus industry. The aim here was to find out things that cannot be inferred from the data. Areas discussed include: the extent to which tendering as opposed to other factors led to change in the London bus industry; the source of cost savings; the impact of tendering on Labour; problems associated with tendering. Interviews suggested that: cost savings stemmed from wage reductions and productivity gains; there are some problems with the bidding process; there is a tension between bus planners and some bus company managers. In certain cases the tendering authority offered contract for tender in bundles. Chapter 6 analyses this policy from theoretical and empirical perspectives and asks was it optimal for the tendering authority. It is concluded that the policy should not be used by London Transport. Finally, in chapter 7, an overall assessment of the tendering process is presented. The focus is on results and policy implications for bus tendering in London and competitive tendering in general. PREFACE Some parts of this thesis are published by the Greater London Group at the London School of Economics in "London Bus Tendering" by D. Kennedy, S. Glaister and T. Travers. Parts of that publication appearing in this thesis are solely authored by me. Part of Chapter 2 of this thesis is published in The International Review of Applied Economics, September 1995. Part of Chapter 4 is published in Transport Policy, December 1995. Part of Chapter 5 is published in Transport Reviews, June 1995. These papers were not written in collaboration with any other person. The remaining parts of these chapters, and chapters 3,6, and 7 contain, to the best of my knowledge, original results and were not written in collaboration with any other person. The support of the Economic and Social Research Council (ESRC) is gratefully acknowledged. The work was part of the ESRC Contracts and Competition Programme and was funded by award number L 114251010. I am very grateful to my supervisor, Stephen Glaister, for his many very helpful comments and suggestions. I would also like to thank Tony Travers, Max Steuer, John Moore, Gustav Nombela, Tommaso Valletti, Phil Goodwin, Michael Banister, Preston McAfee, David Bayliss, and seminar participants at LSE for helpful comments. 4 CONTENTS 1 SURVEY OF THE LITERATURE 10 Introduction 10 Ownership, Competition and Performance. 12 Objectives 13 The principal and agent problem 14 Product market competition 17 Competitive Tendering 19 Tendering versus deregulation in the bus industry 23 The Tendering Process 25 The Auction Mechanism 25 Types of auction 27 Private values 27 Common values 28 Auction revenues 29 Combination auctions 30 Applications to bus tendering 31 Contract Type 32 Contract Specification 33 Vehicle age 34 Contract Length 37 The Tendering Process 38 Conclusion 40 2 THE IMPACT ON COSTS 42 Relative Costs 42 Theoretical Background 42 The independent private values model 43 The common values model 44 Analysis of Bids 46 The model 46 The data 48 Results . 49 Cost Savings 52 Conclusion 54 Appendix: a test of returns to scale 55 3. DEMAND 59 Introduction 59 Analysis based on aggregate data 59 The Model 61 Results 62 The Revenue Impact 63 Analysis of route level data 67 Conclusion 75 4 A WELFARE BALANCE 76 The Impact of Tendering 76 Cost Savings 76 Revenue Gained 78 Gains to consumers 80 The welfare impact of tendering 82 Results 83 Conclusion 84 AppendixiContract type and welfare 86 Monitoring costs and incentives 86 London Transport finances 90 Alternative contracts 94 5 AN ATTITUDE SURVEY 96 Introduction 96 Research 97 The Situation in 1985 97 The Pressure For Change 97 Cost Reduction , 99 The impact of tendering on labour relations 100 The Tendering Process 101 Tendering and specification 101 Resource cost of bidding 102 LBLbids 102 Fairness of awards 103 Monitoring 105 Post Award Innovation 105 Broad Attitudes 106 Bureaucracy 106 Group Planning 106 The Nature of Tendering 107 Other Organisations 108 Local Authorities 108 The Transport and General Workers Union 109 The London Regional Passengers Committee 110 Evidence presented to the Transport Select Committee 111 The Independents 111 LBL Subsidiaries 112 The LT response 112 Summary of views expressed 115 6 BUNDLING OF CONTRACTS 117 Introduction 117 Bundling and Procurement Cost 118 Sale As A Bundle 122 Non Serious Bidding 126 Non Serious bidding Leads to Bumdling 127 Case Study 128 Conclusion 133 7 7 CONCLUSION 135 REFERENCES 143 8 LIST OF TABLES 1. Age distribution of buses and coaches 35 2.1 OLS regression explaining bids for tenders 49 2.2 Restricted OLS regression explaining bids for tenders 51 2.3 OLS regression of pre and post tender costs 53 2.4 Re-specified OLS regression explaining bids for tenders 56 2.5 Least Squares Random Coefficients regression explaining bids for tenders 56 2.6 Re-specified OLS regression of pre and post tender costs 58 3.1 Results from OLS regression explaining changes in ridership 63 3.2 The estimated revenue impact of tendering 66 3.3 Random Coefficients estimation of route demand 69 3.4 Least Squares Dummy Variables estimates for route demand. 71 4.1 Cost savings from tendering in 1992 prices 77 4.2 Revenue gains from tendering in 1992 prices 79 4.3 Consumer benefits from tendering in 1992 prices 82 4.4 The welfare impact of tendering in 1992 prices 85 5 London Buses Limited's bids for routes in the Harrow network 130 1. SURVEY OF THE LITERATURE Introduction In the period before 1984 bus services in London were provided by London Transport (LT). This body was answerable to the Greater London Council (GLC) under legislation passed in 1969. As figure 1.1 shows, between 1963 and 1979 costs per bus mile in the London Bus industry rose in real terms by a factor of 2.3. During the period 1970-1982 they rose by more than 68% and over the same period annual grant paid to London Transport rose from £6.5 million to nearly £85 million in constant prices, a thirteen fold increase. The Government presented these figures in the white paperPublic Transport in London (Department of Transport, 1983) and stated that "new arrangements are needed to secure the cost effective delivery of services from both the public and the private sector". In the White Paper Buses (Department of Transport, 1984) the Conservative Government stated its proposal to deregulate the bus industry outside London.