02 March 2011

How Fare Reviews Affect Public Transport Operators

The review mechanism for fares that public transport operators (mass rapid transit and/or buses, but not taxis) in Singapore are allowed to charge shows the challenging constraints of operating in a regulated environment.

Frequency of review of fares can be changed
Public Transport Council, a body established by an act of parliament, typically reviews fares annually in time for the revised fares to be implemented in July.

However, the dates of the review and/or implementation can be changed, and have been changed in the past.

The review was brought forward in 2009 to allow a fare reduction to be implemented in light of the recession.

This year's review has been deferred to Q4 because of the impending opening of phases 4 and 5 of the Circle Line, an orbital line that connects all the existing rail lines into the city, in Q4.  PTC prefers to have only one fare change in a year.

It is difficult to understand PTC's rationale for deferring the fare review.  Although phases 4 and 5 of the Circle Line will result in some change in commuting patterns inasmuch as it allows commuters to bypass the city centre mass rapid transit exchanges to reach their destinations, PTC's vast database of commuting patterns should enable it to quite accurately forecast the change by mathematical modelling.

PTC's decision means that the public transport operators will miss out on a likely fare increase for possibly three to six months.  What will happen if phases 4 and 5 of the Circle Line are not opened as scheduled?  Will the fare review and fare increase be deferred again?

When a fare review is postponed, the public transport operators face the risk that circumstances may change when the time for the previously postponed review comes around.  If economic conditions deteriorate, will the quantum of the fare increase, if any, be commensurate with that based on the fare review formula (see following discussion on formula)?

The fare review formula
The maximum fare adjustment is 0.5 ΔCPI + 0.5 ΔWI - 1.5%
where:
ΔCPI is the change in Consumer Price Index over the preceding year
ΔWI is the change in Average Monthly Earnings (Annual National Average) over the preceding year, adjusted to account for any change in the employer's Central Provident Fund contribution rate
1.5% is productivity extraction based on half the average productivity gains achieved by public transport operators.
Fare adjustment ceiling
The maximum fare adjustment is "the overall quantum of change in fare revenue that is generated by the changes in fare levels and the corresponding ridership" [1].

When considering any application for approval of any fare, PTC is required by Public Transport Council Act (Cap. 259B) to take into account inter alia "the need for public interest to be safeguarded" and "the need for the [public transport operator] to remain financially viable" (PTC states the latter responsibility as "ensuring the long-term viability of public transport operators" [2]).

PTC will protect commuters' interests by varying or rejecting the fare adjustment in extenuating circumstances such as adverse economic conditions or a significant deterioration in the overall affordability of public transport fares [3].

PTC need not approve a revision equal to the maximum.

Although not every company can always raise the price of its goods and services to fully offset increases in its costs, many companies can, and do, raise the price of their goods and services to fully offset, or more than fully offset, increases in their costs when the circumstances are perceived to be right (typically when the percentage increase in price is greater than the percentage fall in demand).  Otherwise, it is only a matter of time before they fail.

Unlike these companies, public transport operators have no opportunity to raise their fares beyond what PTC is prepared to approve, and that is capped.  Nevertheless, the public transport operators can derive some comfort from PTC's having to take into account the need for them to remain financially viable.

Cumulative effect of annual adjustments
The difference between the maximum allowable fare adjustment and the actual fare adjustment has a cumulative effect over time.

To see this, assume that the maximum allowable fare adjustment is 1.5 per cent and the approved fare adjustment is 1.1 per cent in Year 1.  At the fare review in Year 2, the fact that the 0.4 per cent was not awarded to the public transport operators in Year 1 is not taken into account; it has vanished forever.  If there is another difference of, for example, 0.3 per cent in Year 2, this again represents another 0.3 per cent revenue that could have accrued, but did not accrue, to the public transport operators.

Because the actual fare adjustment is always less than, or equal to, the maximum allowable fare adjustment, the difference between the two increases, rather than approach zero, over time.

CPI and WI
The formula assumes that wages account for 50 per cent of the expenses of the public transport operators for 2008 through 2012.

The formula also assumes that changes in the non-wage costs (depreciation of rolling stock and buses, fuel or electricity etc.) of the public transport operators are adequately accounted for by ΔCPI.  However, CPI is the consumer price index.

To the extent that these relationships do not hold, the public transport operators have to manage their costs within the limits of the approved fare adjustment if they wish to remain profitable, or sufficiently profitable.

The ΔCPI and the ΔWI used in the formula are the ΔCPI and the ΔWI of the preceding calendar year.  The revised fare typically takes effect in July of the current year through to June of the following year.

Productivity gain extraction
The maximum allowable fare adjustment extracts a 1.5 per cent productivity gain (or half the recent annual productivity gain of 3 per cent).  The aim is to motivate the public transport operators to be efficient in their operations and encourage productivity improvements.  Whilst PTC does not have to adjust fares upwards by the full value of 0.5 times ΔCPI or 0.5 times ΔWI, PTC must adjust fares downwards by the full 1.5 per cent productivity gain.

Fares will be adjusted downwards unless the annual productivity gain of the public transport operators exceeds 1.5 per cent (before taking into account ΔCPI and ΔWI).

This is a very interesting way to impose productivity gains on the public transport operators, even if they had managed to achieve gains of such magnitude previously.  If they raise their productivity, the productivity extraction may be higher when the formula is reset; the productivity extraction factor was only 0.3 per cent from 2005 to 2007.  If they do not maintain their past productivity, their profitability may be affected.  In the decade ending 2009, the national annual productivity gain in Singapore was only 1 per cent [4].

Public transport operators are required to meet quality standards.  The more frequently buses or trains run, the lower their productivity if ridership is unchanged.

Finally, the productivity extraction is made at the top line (i.e., revenues) whereas productivity is typically measured in terms of value-added.  SBS Transit's value-added was 58 per cent of revenues [5] and SMRT's was 69 per cent of revenues [6].  Assuming value-added of 60 per cent of revenues, the productivity extraction of 1.5 per cent requires the public transport operators to achieve productivity gains of 5.0 per cent per annum.

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Notes:

1.  "Annual Fare Review Process" Public Transport Council website.

2.  "Fare Regulation Framework" Public Transport Council website.

3.  Report of the Committee on the Fare Review Mechanism (Feb 2005).

4.  Report of the Economic Strategies Committee (Feb 2010).

5.  SBS Transit Ltd annual report 2009.

6.  SMRT Corporation Ltd annual report 2010.


This posting was originally published on 2 February 2011.

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