Beyond the quiet life of a natural monopoly: Regulatory challenges ahead for Europe’s rail sector Issue paper # 2 Competition and cooperation, organisations and markets: how to deal with barriers to entry and market power? John Preston (University of Southampton) October 2012 121025_CERRE_CES_Rail_IssuePap2_JP Centre on Regulation in Europe (CERRE) asbl rue de l’Industrie, 42 (box 16) – B-1040 Brussels ph :+32 (0)2 230 83 60 – fax : +32 (0)2 230 83 60 VAT BE 0824 446 055 RPM – [email protected] – www.cerre.eu Table of content About CERRE .....................................................................................................................................3 About the author ..............................................................................................................................5 Executive summary ..........................................................................................................................6 Introduction ......................................................................................................................................7 1. Barriers to Entry .......................................................................................................................9 2. Practical Evidence .................................................................................................................. 12 On track competition ................................................................................................................. 12 Off track competition ................................................................................................................ 17 3. Theoretical Evidence ............................................................................................................. 24 4. Summary and Conclusions .................................................................................................... 27 5. References ............................................................................................................................. 31 121025_CERRE_CES_Rail_IssuePap2_JP_All 2/35 About CERRE Providing top quality studies, training and dissemination activities, the Centre on Regulation in Europe (CERRE) promotes robust and consistent regulation in Europe’s network industries. CERRE’s members are regulatory authorities and operators in those industries as well as universities. CERRE’s management team is led by Dr Bruno Liebhaberg, Professor at the Solvay Brussels School of Economics and Management, Université Libre de Bruxelles. CERRE’s added value is based on: • its original, multidisciplinary and cross sector approach; • the widely acknowledged academic credentials and policy experience of its team and associated staff members; • its scientific independence and impartiality. CERRE's activities include contributions to the development of norms, standards and policy recommendations related to the regulation of service providers, to the specification of market rules and to improvements in the management of infrastructure in a changing political, economic, technological and social environment. CERRE’s work also aims at clarifying the respective roles of market operators, governments and regulatory authorities, as well as at strengthening the expertise of the latter, since in many member states, regulators are part of a relatively recent profession. This issue paper has been prepared within the framework of a CERRE Executive Seminar which has received the financial support of a number of stakeholders in the rail industry including CERRE members. As provided for in the association's by-laws, it has been prepared in complete academic independence. Its contents and the opinions expressed 121025_CERRE_CES_Rail_IssuePap2_JP_All 3/35 in the document reflect only the author's views and in no way bind either the CERRE Executive Seminar sponsors or any member of CERRE (www.cerre.eu). 121025_CERRE_CES_Rail_IssuePap2_JP_All 4/35 About the author Prof. John Preston is Head of the Civil, Maritime and Environmental Engineering and Science Academic Unit of Southampton University. He was previously Director of Southampton’s Transportation Research Group and Head of the School of Civil Engineering and the Environment. His research interests in transport cover demand and cost modelling, regulatory studies, and land-use and environment interactions. His initial work concentrated on rail, but subsequent work has covered all major modes of transport. He is a member of the World Conference on Transport Research Society’s (WCTR) Scientific Committee, the Co-Chair of the WCTR Rail Special Interest Group, a Committee Member of the International Association of Rail Operations Research (IAROR) and of the International Conference on Competition and Ownership in Land Passenger Transport. 121025_CERRE_CES_Rail_IssuePap2_JP_All 5/35 Executive summary The first three “European Railway Packages” have opened up freight and international passenger markets to competition. Achieving an open market in the case of national passenger rail markets is one of the main goals of the forthcoming 4th package, although several Member States have already implemented national level reforms. This paper reviews the evolution of competition in and for rail services in Europe. It starts off by reviewing some of the economic characteristics of the railway industry and by examining the role of barriers to entry and exit and of reaction periods. Two main types of competition co-exist: in the market (open access) and for the market (franchising or competitive tendering). Recent practical and theoretical evidence is reviewed with respect to Europe in general and to Great Britain more specifically. A taxonomy of barriers is developed and is used to assess competition models based on open access passenger and freight services, competitive tendering and franchising. It is found that open access passenger services may be particularly problematic and are likely to be a niche activity. Franchising or tendering may be a more effective way of introducing widespread competition for passenger services. Open access freight services may be less problematic, but still face substantive barriers, particularly for international services. However, all competitive models may be threatened by mergers and acquisitions and the creation of monopolies. 121025_CERRE_CES_Rail_IssuePap2_JP_All 6/35 Introduction The background to this paper is given by the four packages of railway reforms undertaken by the European Commission. The First Railway Package originated in 2001 and made provisions for open access competition in the international rail freight market, initially on the Trans European Rail Freight Network. The Second Railway Package was outlined in 2004 and extended rail freight deregulation to the whole network (realised in 2007). It also included directives for the harmonisation of safety requirements and certification, and for interoperability, as well as a regulation for the creation of a European Railway Agency (ERA) for safety and interoperability. The Third Railway Package was approved in 2007 and includes the liberalisation of international passenger services by 2010, the harmonisation of train drivers’ licences and the inclusion of passenger rights and freight service quality regulations. A fourth package of reforms is currently under consideration, with the emphasis on open access competition for domestic services. It also considers mandatory competitive tendering for public sector contracts, the harmonisation of regulation through the ERA and framework conditions concerning the independence of infrastructure managers and access to stations and facilities, through ticketing and inter- available ticketing. It is not the purpose of this paper to give a detailed review of these reforms. This is given elsewhere (see, for example, Holvad, 2009). Instead, the starting point to this paper is earlier work on barriers to entry in the rail industry (Nash and Preston, 1992). This is partly of historic interest. Although there had been reforms in North America, with deregulation in the US in 1980 and liberalisation in Canada in 1987 (Grimm and Rogers, 1991), reforms in Europe were in their infancy, although Sweden had begun on its path to reform (in 1988) and the European Commission had passed the ground breaking directive 91/440. Aside from the three railway packages outlined above, key subsequent developments have included the corporatisation and partial deregulation of Deutsche Bahn (DB - Germany) in 1994 and the privatisation of the British Rail system around 1996/7, resulting in some open access operations. Our initial perspective on barriers to entry will be presented in section 2. Building on Preston (2009), Section 3 will review the practical evidence and section 4 the theoretical evidence that has emerged as the reform process has progressed, particularly in Europe. In section 5, we will attempt to summarise, using 121025_CERRE_CES_Rail_IssuePap2_JP_All 7/35 some of the some of the findings from the McNulty review, and we will draw some tentative conclusions that might form the basis for future discussions. 121025_CERRE_CES_Rail_IssuePap2_JP_All 8/35 1. Barriers to Entry Nash and Preston (1992) highlighted three main features of railway economics that might be considered constants. The first is the high degree of fixity and sunkeness of infrastructure costs. The second is the economies of density that stem, in part, from these high fixed costs and are exacerbated by the indivisibilities