Prices of Southeastern’s regulated fares increased very sharply in January 2010, some by up to 12.8%, an extraordinary 8 percentage points (pp) more than the 12-month change in the All-items Retail Price Index to July 2009 which is used as a basis for increases.

We knew that Southeastern were subject to an “RPI + 3pp” formula for regulated fares and were led to expect[1] that the (weighted) average of regulated fares would increase by that amount. Yet it is now clear that “RPI + 3pp” is generally about the minimum increase for individual regulated fares this year, so the weighted average regulated fare rise this year will be considerably in excess of this.

So what’s been going on? The SRTA Committee has had several contacts with Southeastern management who have provided some clarification. Our current understanding of the position is as follows.[2]

Revenue is regulated not fares as such

The regulated fare regime that applies to Southeastern and other Train Operating Companies (TOCs) is very highly regimented. The TOCs are permitted to earn revenues within a regulated “farebox” which is contained by a cap and collar arrangement (See Chart 1). If regulated fare revenue exceeds the cap, the excess is, in effect, taxed at 100% and is used by the Department for Transport (DfT) to reduce the passenger subsidy paid. If regulated fare revenues fall below the collar, the DfT is obliged to increase the subsidy.

Chart 1

Stylised “cap and collar” arrangements

So the emphasis of the regulated fare regime is not on fares per se but on revenues (the product of fares and the number of tickets sold (volume)). Should revenues threaten to fall below the collar, then the TOCs are permitted by the DfT to increase fares (subject to no individual fare being increased by more than a further 5pp) to restore regulated revenue to the “RPI + 3pp” annual growth targeted for the regulated farebox. The farebox calculation is not linked to the actual level of passenger journeys.

The recession led to a fall in train usage overall and thus to a marked slowdown in revenues (Chart 2). So fares are being increased, not just to compensate for inflation but for an unexpected drop in traffic. The logic of this remarkable arrangement (“what other private companies have their earnings underwritten during an economic downturn?”) is that were revenues to fall off not because of a decline in economic activity (which the TOCs cannot be held responsible for) but because of the impact of a rapid rise in fares, the TOCs would be able further to increase fares to compensate for the price-induced decline in revenue!

Chart 2
Passenger journeys and revenue

Source: Office of Rail Regulation, National Rail Trends, Rail Usage, January 2011.

Data are for franchised London and SE operators and include allservices (i.e. both regulated and unregulated fares).

The arrangement is also symmetrical. Were traffic and regulated revenue grow faster than expected because of a strong economic recovery the ‘RPI + x’ formula will be moderated to put actual revenues back on target (See Chart 3). Rail travellers, who experienced what appeared to be a steady growth in rush-hour passenger numbers and overcrowding during much of the 2000s until the onset of the recession, yet also saw their fares being regularly increased each year, may be highly sceptical. We do not have access to Southeastern’s numbers to verify the symmetry. However, there is some indirect evidence in that regulated fares for London and South Eastern operators collectively were roughly the same in real terms in January 2010 as they had been in January 1998, although the ‘RPI +x’ formula applied throughout that period. In fact, they fell in real terms between January 1998 and January 2003 before rising 8.9% between January 2003 and January 2010 (Chart 4).
Chart 3
Stylised regulation of the “farebox”

In the “Base” case, the regulated farebox grows at RPI + 3pp per year.In the “Fare Reveune Shortfall” case actual regulated fares revenues grow only by 2% in year 1. Fares are raised in year 2 by an amount that restores revenues in year 2 to the base case level in year 2 (subject to no individual fare rising by more than an additional 5pp).In the “Fare Revenue Excess” case, actual regulated fares revenue in year 1 grows by more than RPI + 3pp. Fare increases in the following year are constrained to produce a level of revenue equal to the base case in year

Chart 4
Trend in regulated fares

Source: Office of Rail Regulation, National Rail Trends Yearbook 2009-10

In theory, rail traffic and revenues could also expand, not because of a general strengthening of the economy but because of the efforts of Southeastern to improve its service to passengers. However, rather than being rewarded for this, Southeastern would find its ability to increase fares thwarted by the farebox mechanism. The current (dis-) incentive structure seems to leave a lot to be desired for both train users and operators!

Position of DfT: A conflict of interests?

You might ask, isn’t the DfT conflicted? On the one hand it has a responsibility to rail users to ensure they are not exploited by, in effect, a monopoly supplier of train services. On the other, they have responsibilities towards taxpayers to ensure that the level of subsidies paid reflects government policy. Unfortunately for rail users, it is pretty clear which group has priority within the DfT as successive governments have been committed to reduce the subsidy to rail transport.

In FY2008-09, the latest year for which data on subsidies are available, Southeastern received £35.6 million of a total of £254.7 million net amount paid to all operators. This represented a subsidy of 0.9p per passenger kilometre. The highest subsidy paid was £224 million to First ScotRail (or 8.6p per passenger km). On the other hand National Express East Coast paid the DfT £184.9 million t (a negative subsidy of minus 3.9p per passenger km). So there is considerable cross-subsidisation between TOCs, with generally lesser-used services in the remoter parts of the country receiving funding from more populous regions / busier routes.

Remaining uncertainties

There are several details which remain unclear. For example, the regulated farebox was expanded with the introduction of High Speed 1 (HS1) and there are suspicions that a slower than expected take-up of HS1 is one reason for the very sharp rise in Southeastern fares generally. The farebox is not divided into service sectors, it is just an aggregation of all income. It also appears that the RPI formula which applied to TfL area services operated by Southeastern was more favourable (RPI +2pp) than that which applied to other Southeastern services. In effect, users of Mainline services have been required to subsidise users of TfL Metro services.