Transport Policy 19 (2012) 26–35

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Transport Policy

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journal homepage: www.elsevier.com/locate/tranpol

The distinction between commercial and non-commercial bus servicesin Germany: Given by nature?

Arne Beck n

Karlsruhe Institute for Technology (KIT), Institute for Economic Policy Research (IWW), Department for Network Economics, Kaiserstraße 12, 76131 Karlsruhe, Germany

a r t i c l e i n f o

Available online 29 September 2011

Keywords:

Public transport

Bus

Tendering

Regulation

Commercial service

Market organization

0X/$ - see front matter & 2011 Elsevier Ltd.

016/j.tranpol.2011.06.004

viations: y, paragraph; BGBl, bundesgesetz

rcial lines or services (see glossary for furthe

ur Entflechtung von Gemeinschaftsaufgaben un

tungsgesetz (Demerger Act); EU, European Unio

emeindeverkehrsfinanzierungsgesetz (Local Au

sary for further explanations); LA, licensing auth

tions); o, operator; PBefG, Personenbeforderung

glossary for further explanations); PT, public tr

y (see glossary for further explanations); PTP, (

sary for further explanations); RegG, Regionalisi

onalization of Public Transport, see glossary for

ungsordnung fur Leistungen, Teil A (Official Ger

f Service Performance Contracts, Part A)

þ49 178 2062746.

ail address: arne.beck@iww.uni-karlsruhe.de

a b s t r a c t

German public transport services by bus are characterized by a regulatory framework that distin-

guishes between commercial and non-commercial services. Contrary to the apparent views of

legislators, this paper shows that costs and revenues are not the only parameters determining whether

or not operators are able to provide services in a commercially viable way.

Apart from the local characteristics of the specific service, we show that the classification of services

as commercial versus non-commercial is determined in large part by the public transport authorities

that set minimum quality standards to be provided by operators. Our analysis shows that the

authorities awarding the contracts in some cases affect market organization significantly depending

on how they make use of this power. Furthermore, market organization differs substantially with

respect to the awarding structure and the contractual relationships, thus creating a challenge for

operators and authorities in an embryonic market.

& 2011 Elsevier Ltd. All rights reserved.

1. Introduction

The institutional framework of the German public transportbus services is characterized by a fundamental distinctionbetween commercial and non-commercial services. Legislatorsappear to view the distinction as unambiguous, since – in theirthinking – the costs and revenues of public transport bus servicesare mainly determined by local conditions (population density,land use patterns, etc.). For example, the revenue potential of anurban bus line will usually be higher than that of a rural one.Conversely, costs per vehicle kilometer will usually be lower inrural districts than in cities due to the higher average speed.

All rights reserved.

blatt; CCL, competition for

r explanations); EntflechtG,

d Finanzhilfen, or

n; EC, European Community;

thority Traffic Financing Act,

ority (see glossary for further

sgesetz (Passenger Transport

ansport; PTA, public transport

local) public transport plan

erungsgesetz (German Law on

further explanations); VOL/A,

man Contracting Terms for

If the distinction was in fact unambiguous, classifying servicesas commercial or non-commercial would depend mainly on thelocal characteristics of the specific service, and would thus begiven exogenously (‘‘given by nature’’). The question arises whetherlocal conditions are the only distinguishing feature for operators, orwhether market participants also can have a significant impact onthis distinction. Considering the usual influence of authorities withinthis industry, it is fair to assume that their activities do have a majorimpact on the distinction between commercial and non-commercialservices. To enable further analysis, the regulatory framework has tobe examined to consider the possible courses of action available tomarket participants, and their main activities and prospects. Thecurrent legal framework, which forms the basis for the subsequentdiscussion, will therefore be described in Section 2. This institutionalframework is then transferred into a theoretical framework inSection 3, which will constitute the starting point for our analysisof market participants’ possible courses of action and a discussionof the results from the different viewpoints of authorities andoperators in Section 4. Here, we will also analyze whether marketparticipants have a major influence on the categorization of theirservices. In Section 5, we present the key findings and conclusions.An index, including a list of abbreviations, a list of symbols and aglossary are included to ease understanding of specific terms forreaders unfamiliar with the regulatory framework of German publictransport by bus. For more details, see also Beck (2009a,b).

Regulatory and institutional frameworks and their effects onthe public bus transport market have been the subject of manypapers. The first discussion was Chadwick (1859), who analyzed

Nomenclature

List of symbols

a fixed costs for operatorsC cost functionCP compensatory payments charged to the budget of the

authorityEo[CP] level of compensatory payments expected by operatorEo[FR] level of fare revenues expected by operatorEPTA[CP] level of compensatory payments expected by PTAEPTA[FR] level of fare revenues expected by PTA

FR(q) fare revenues (depending on the quality level delivered)mq minimum quality level defined by the PTA in its PTPOR other operational revenuesq quality delivered by operatorqa additional quality exceeding mq

SDS supplementary direct subsidies necessary to enable anon-deficitary delivery of services by operators on theminimum quality level mq

SFR subsidies for fare reductionsT threshold (see glossary for further explanations)p profits for operators

A. Beck / Transport Policy 19 (2012) 26–35 27

competition for a field (regulated competition) as compared tocompetition within it (unregulated competition or free marketregime).

More recently, tendering models for (non-commercial) busservices have been analyzed in several international articles (e.g.,Alexandersson and Pyddoke, 2003; Hensher and Wallis, 2005;Amaral et al., 2006; Mathisen and Solvoll, 2008). Furthermore,some papers have analyzed free, unregulated (commercial) marketregimes (e.g., Romilly, 2001; Roberts, 2005; Gomez-Lobo, 2007;Leopairojna and Hanoaka, 2007) with a focus on Great Britain aswell as South American and Asian countries.

General aspects of different market models have been discussedonly in a small number of papers (e.g., Macario, 2005; van de Velde,2007). van de Velde et al. (2008a, pp. 113–115, pp. 24–25) havedescribed the different European forms of market organization withrespect to the right of initiating ‘‘the creation of passenger transportservices’’ now made possible by new regulation (EC) No. 1370/2007.

In the German literature, the distinction between commercialand non-commercial services has been analyzed primarily bylawyers (e.g., Werner, 2004; Landsberg, 2003). Economic papers onthe institutional framework of German public transport services bybus are rare. Some articles focus on the economic effects oftendering (e.g., Achenbach, 2006; Beck and Wanner, 2007, 2008)and a limited number of papers consider competition for commer-cial services (e.g., Beck and Wille, 2009; Walter et al., 2009).

Nevertheless, to the best of my knowledge, economic papersanalyzing the effects of commercial and non-commercial serviceswithin one (regulated) market have not yet been published.It may be one reason why researchers – as well as global playersentering the German public transport market – usually describethe regulatory framework as initially incomprehensible.1 Thepresent paper therefore aims to narrow the knowledge gap byproposing the first comprehensive economic analysis of the mainaspects of the institutional framework of the German bus industryand the distinction between commercial and non-commercialservices. The results provide an understanding of the mainoptions for action for market participants and are relevant forresearchers, businesspeople and policymakers.

2 See Hickmann (2004, p. 34), Sterzenbach (2008, pp. 75–104) and

Wissenschaftlicher Beirat beim BMVBS (scientific council at the federal Ministry

of Transport) (2008, pp. 82–86) for a detailed explanation of the financing

structure in Germany.

2. The current institutional framework

The distinction between commercial and non-commercialservices is one of the key elements of the German institutionalframework for public transport services by bus effective in 2009.The characteristics of commercial and non-commercial services in

1 At least this is my experience from five years of consultancy work for the

German public transport system, now working at civity Management Consultants,

and from numerous discussions with foreign researchers.

terms of financing and/or exclusive rights and the modes ofawarding these instruments of compensation will be explainedin the following chapter. These explanations will form the basisfor the theoretical framework to be developed for the analysisthereafter.

2.1. Financing structure for commercial and non-commercial

services

The funding structure of local and regional public bus trans-port services in Germany is characterized by a system of subsidiesprovided by all three tiers of the government.2 Payments aremade using a broad variety of instruments. In the following,I describe, based on Fig. 1, the basic funding structure of thepublic bus transport services, divided according to the mainsources at the federal, state and local levels.

The federal level (the top tier: the Federal Republic ofGermany) provides direct co-funding for selected long-terminvestments in major infrastructure projects. These are based onthe Local Authority Traffic Financing Act (Gemeindeverkehrsfi-nanzierungsgesetz—GVFG). Furthermore, the federal governmentwaives taxes through reduced tax scales and tax exemptions forpublic transport (e.g., for value added tax and motor vehicle tax).

The states (the second tier: the Lander) also waive some taxrevenues to assist the industry. To be able to subsidize publictransport services within their territories, the states receive‘‘Regionalisierungsmittel’’ (regional funds, paid according to y 5of the Law on the Regionalization of Public Transport (Regiona-lisierungsgesetz—RegG)). These funds, which amounted to h6.675billion in 2008, are used primarily for funding rail services.Nevertheless the states also use a portion of these funds forgeneral public transport purposes.3

Furthermore, the states receive funds amounting to h1.336billion per year from the federal government to support infra-structure investments (e.g., for depots) and/or vehicle invest-ments at the local level.4 Two other state-level instruments ofprimary importance for bus services are compensation paymentsto operators for reduced fares for pupils (including trainees andstudents up to a specific age) and the disabled under y 45a of thePassenger Transport Act (Personenbeforderungsgesetz—PBefG)

3 See SCI Verkehr GmbH (2006) and Wissenschaftlicher Beirat beim

BMVBS—Bundesminister fur Verkehr, Bau und Stadtentwicklung (2008, p. 8).4 See yy 1 and 2 GVFG and the Demerger Act (Gesetz zur Entflechtung von

Gemeinschaftsaufgaben und Finanzhilfen also known as Entflechtungsgesetz—

EntflechtG).

Federal level (Federal Republic of Germany)

Localauthoritytraffic finan-cing act(direct co-funding oflong terminvest -ments)

Regional funding (primarilyfunding of rail services, butalso general PT funding)

Tax exemptions

Local authority traffic financingact funds for federal states

State level (Länder)

General subsidies forpublic transport

Local authoritytraffic financingact paymentsfor infra-structure/vehicles

Local level (local or regional authorities,usually responsible Public Transport Authorities (PTAs))

Subsidiesto publictransportassociations

Compensatorypayments(pupils,disabledpassengers)

Supplementarydirect subsidies

Infrastructure(municipal partof GVFG-funding) Classified as

"other operationalrevenues" or

Passengers

Passengerrevenues

Take over of costsfor tickets forpupils Paid for non-com-

mercial services

Transport companies (with a focus on bus operators)

In most of the regions: public transport associations (Verkehrsverbünde) acting asclearing houses for passenger revenues (sometimes entrusted with PTA/subsidy payments too)

Fig. 1. Scheme of funding structure for public transport services by bus (main aspects). Source: based on Hickmann (2004, p. 34) and Sterzenbach (2008, p. 80).

A. Beck / Transport Policy 19 (2012) 26–3528

and yy 145ff of the Ninth Code of Social Law, provided for operatorsdirectly. According to Hickmann (2004, p. 34) and Sterzenbach(2008, p. 93), compensation for reduced pupil fares is one of themain sources of public funding for operators of short-distanceservices in the public transport system. The states can also makeother payments to local or regional authorities enabling them tofund their public transport services directly.

The local or regional authorities (the third tier), which usuallyact as public transport authorities (PTAs) for bus services, providesubsidies for infrastructure investments under the GVFG throughco-financing subsidies. Some local school authorities cover theremaining costs of pupil public transport tickets.

Where necessary to ensure an adequate level of service from aPTA point of view, direct supplementary subsidies are paid tooperators by the PTAs. Whether these payments are considered as‘‘other operational revenues’’ or not forms the fundamental basisfor distinguishing between commercial and non-commercialservices. If these subsidies are categorized as ‘‘other operationalrevenues’’, the services are classified as commercial according to8 (4) PBefG, although direct subsidies are paid. When notcategorized as ‘‘other operational revenues’’ by the PTA and/orthe operator, the services are classified as non-commercial.

To enable municipal operators to deliver adequate levels ofservice, deficit compensations and cross-subsidies5 are also the

5 Cross-subsidies are financial benefits resulting from reduced corporate tax

payments due to interconnected associations with profitable public companies

(such as municipal energy suppliers).

usual instruments for supplementary funding of public transportservices by PTAs. Direct awarding is not the intended focus of ouranalysis, and the funding of municipal operators will not beconsidered in detail here.

In many regions there are public transport associations(Verkehrsverbunde).6 A study by Graetz et al. (2007, p. 11) usinga database of 150 German PTAs, showed that 80% of the PTAs dohave a public transport association in their area. Some states –usually in coordination with PTAs – subsidize the public transportassociations in their territory. Usually these associations act asclearing houses to distribute fare revenues between operators.Several associations have also been entrusted with the duties ofPTAs at the regional and/or at the local level, including theprovision of (supplementary) subsidy payments to operators.

As can be seen, even an outline of the main aspects of thefinancing structure in Germany is rather complex. Moreover, thefinancing structure differs between the states and often also differsat the regional and/or local level without any clear obligation forauthorities to publish information on public funding.7

Our examination shows that German legislation providesauthorities with a certain level of freedom to structure theirfinancing schemes according to their local needs. In contrast tothe incumbent operators, the multitude of financing instrumentsavailable makes it difficult for newcomers to assess the subsidies

6 See van de Velde et al. (2008a, p. 53) for a short explanation of the German

Verkehrsverbund.7 See Sterzenbach (2008, pp. 97–101).

Public Transport Authority(PTA) gy

intoaccount

Licensing authority(LA)

Licensing authoritygrants licence

according to approvedapplication form of

operator

Operator applies forlicence to operate

Operator

Strong / formal relationshipWeak / informal relationship

Licensing authoritymust take PTP of PTA

into account

Licensing authorityhas to take care

of integrationof public transport

services

PTA has to includeoperators in dis-

cussion among PTP

Fig. 2. Main participants within the market for commercial services. Source: own figure.

A. Beck / Transport Policy 19 (2012) 26–35 29

to be expected. Sterzenbach (2008, p. 105) therefore classifies theGerman financing structure for public transport with its numer-ous financing sources and streams as ‘‘intransparent.’’8

2.2. Awarding of exclusive rights for commercial services

There are three main participants in the market for commer-cial public transport services to passengers: the PTAs, the licen-sing authorities (LAs), and the operators. Fig. 2 provides a briefoverview of the obligatory collaboration among commercialservices under the PBefG.

If operators decide to initiate new, or to continue existingcommercial services, they must apply for a license to operate theseservices which is granted by the LA (see y 2 (1) and y 11 (1) PBefG).The application must contain the major characteristics of the serviceplanned, e.g., length and route of the line, timetable, tariff system,and number and type of vehicles (see y 12 (3) PBefG). The licensemight be granted for only one line, or for an entire network (see y 9(2) PBefG), e.g., a city. Following approval by the licensing authority,operators are obliged to deliver the service.

The responsibilities of LAs within the national market are tosafeguard the security of operations for passengers and to securethe continuous delivery of services to passengers during both thevalidation of applications and the license term. The LAs maintasks are to provide access to the profession and, in case ofcommercial services, to provide access to the market—both ofthese through the granting of licenses. They must reject applica-tions if they expect problems with the security or continuousdelivery of public transport services (for minimum requirementsfor market entry, see y 13 PBefG and Werner, 2001, pp. 61–63).9

The LAs’ obligation to ensure commercial stability for existingservices includes the duty to reject new applications to establishcommercial services if the demand for public transport can be

8 See also the statement by the Wissenschaftlicher Beirat beim BMVBS—

Bundesminister fur Verkehr, Bau und Stadtentwicklung (2008, p. 82), which

describes the German financing structure as ‘‘historically developed, complicated

and widely intransparent.’’9 According to Gerrit Landsberg, the main focus is essentially on awarding

concessions, and includes very weak instruments to withdraw authorizations or

impose fines if operators do not deliver services as promised (see also yy 25 and 61

PBefG).

met by existing providers. An incumbent provider may also agreeto adapt part or all of the proposals of competitors if profitable(see Werner, 2001, p. 97). This design of an exclusive right10 grantedvia a license (see y 13 (2) PBefG and BLFA—Bund-LanderFachausschuss Straßenpersonenverkehr, 2006, p. 2) may explainwhy the competing applications of newcomers against existing linesare seldom observed during the license term. Nevertheless, they arelegal (see Beck, 2007, p. 426). During the license term, the LAs act asinspection authorities to secure the delivery of public transportservices (see y 54 PBefG and Werner, 2001, pp. 131–145).

In fulfilling their responsibilities, LAs have to take the (local)Public Transport Plan (PTP) into account without any clear guide-lines on this subject (y 8 (3) PBefG) and they may deny applica-tions which do not comply (y 13 (2a) PBefG). According to Werner(2001, p. 90) and Gerrit Landsberg, PTPs are nevertheless usually aminimum standard for LAs that always depend on the level ofdetail in the PTP established by the respective PTA.

When operators submit competing applications to operatespecific commercial services, this situation is classified as Com-petition for Commercial Lines or services (CCL). If a CCL occurs,the LAs still must validate the offers with respect to compliancewith the above-mentioned minimum criteria (security aspects,economic capability, reputation, delivery of appropriate serviceaccording to PTP, etc.; see yy 12, 13, and 14 PBefG and Werner,2001, pp. 90–102). This represents an examination to preventnegative selection.11 In a second step, LAs must select the best ofthe remaining offers with respect to public interests (mainlyquality aspects from a passenger point of view, e.g., frequency,tariff system, etc.; see Werner, 2001, pp. 102–104).

Licensing authorities also have the obligation to look after theintegration of public transport services (according to y 8 (3) PBefG),especially cooperation schemes such as tariff or public transportassociations (Verkehrsverbunde). Please note that they merely haveto take this issue into consideration when making their adminis-trative decisions, without a clear obligation to initiate activities inthis matter.

10 Please note that lawyers are still discussing the extent of this ‘‘exclusive

right’’; see inter alia Werner (2004, pp. 91–96).11 Examination to prevent (or reduce) hidden characteristics because of

informational asymmetry.

13 For non-commercial services, any necessary information on the financing

structure is usually provided in the tendering documents.14 Altogether, n¼117 CCL cases in the period 2003–2008 and various tender-

A. Beck / Transport Policy 19 (2012) 26–3530

The rights and obligations of the PTAs are limited within themarket for commercial services. According to y 1 RegG, their maintask is to determine and secure an adequate minimum level ofpublic transport service for the citizens in their territory. It is thePTAs’ responsibility to provide services of general interest.12 Gen-erally, a direct contractual relationship between PTA and licenseedoes not exist within the market for commercial servicesand the PTPis seen as the PTAs’ main instrument for fulfilling its obligation toprovide an adequate level of services (see Barth, 2001, pp. 56–63and pp. 94–97, for the importance of the PTP in this matter). PTAsmust incorporate operators into the establishment of the PTP.

2.3. Granting of supplementary subsidies for non-commercial

services

If the provision of services is not commercial in that it usesexclusive rights only, supplementary direct subsidies are neces-sary. If these funds are not categorized as ‘‘other operationalrevenues’’, the specific services must be classified as non-com-mercial. According to y 8 (4) PBefG, PTAs are then obliged toaward these subsidies. This is usually carried out through tender-ing procedures under the legal jurisdiction of the Official Contract-ing Terms for Awarding Service Performance Contracts, Part A(Verdingungsordnung fur Leistungen—VOL/A).

Following the award of the contract, the winning bidder mustapply for a license to operate, usually through a formal procedure forLAs only (see Werner, 2001, p. 36). In case of a competing applicationfor commercial services, LAs must decide in favor of the commercialmarket initiative (priority of commercial services; see y 8 (4) PBefGand Werner, 2001, pp. 82–83), as long as the minimum criteria aremet. At present, this is also the case during or after a tenderingprocedure, as long as the LA has not approved the service.

It is important to note that PTAs usually do not have any directinfluence on the procedure for controlling the quality provided bythe operator of commercial services by the LA. They may onlynotify when quality is not delivered by the operator as specifiedin its application, in contrast to the use of a public service contractwith clear obligations.

Summing up, permits for commercial and non-commercialpublic transport bus services in Germany are awarded through asystem of a (controlled) competition for the market. Furthermore,the role of the PTAs is weak within the market for commercialservices compared to their strong position in the business of non-commercial services.

2.4. Barriers to market entry for newcomers

Examining the level of competition for these markets aspresented by recent studies (see Beck, 2010, 2011) shows clearlythe presence of barriers to entry for newcomers. For tenderingprocedures entry barriers have been identified for several con-tract conditions, particularly for the volume tendered out and therevenue risk to be borne by the operator. Moreover, comparingthe non-commercial to the commercial market segment shows asignificantly lower number of bidders per procedure for the latter.Clearly, the barriers impede competitive developments in anembryonic market that relies on market initiatives by operators.The analysis shows key entry barriers in the institutional frame-work: for potential market entrants the overall uncertaintyregarding competitive procedures for commercial services issignificantly higher than usual in tendering procedures and posesdisadvantages primarily for them as opposed to incumbents.

12 See Forsthoff (1938, pp. 36–37) and EU Commission (2001) for the

classification of public transport (PT) services as services of general interest.

Moreover, the complex financing structure of public fundingadds to the level of uncertainty for commercial services from anewcomer’s perspective.13

The upcoming amendments of the national legal framework toinclude the new regulation (EC) No. 1370/2007 may change theexisting framework to some extent. But, according to official pro-nouncements, a major change of the regulatory system as it exists in2009 (e.g., parallel provision of commercial and non-commercialservices) cannot be expected (see, for example, the first officialproposal to amend the PBefG, published by the federal Ministryof Transport (the ‘‘Proposal,’’ see BMVBS—Bundesministerium furVerkehr, Bau und Stadtentwicklung, 2008)).

3. A theoretical model that captures the current institutionalfeatures

To enable an analysis of the interaction between commercialand non-commercial services, we now transpose the currentinstitutional framework into a more theoretical setting. Thefollowing assumptions and definitions are based on the descrip-tions presented in Chapter 3 and on procedures observed invarious cases.14 The focus will be on the competitive bus market.We will not discuss direct awarding of licenses.15

A license provides an operator with real exclusivity for thelicense term and is granted as compensation for the delivery ofservices of general interest. The license obliges the operator todeliver the service as promised for the entire license term.Awarding of licenses to operate specific public transport busservices will take place either through quality competition CCLor through price competition for supplementary direct subsidiesfor non-commercial services (tendering).

The auction design for tendering procedures will be based onthe first-price auction method (bid within closed envelope, onlyone trial, no negotiations before awarding to winning bidder,see Krishna, 2002, pp. 2–3), as is recommended (and usual) forbus tendering procedures (see VDV—Verband Deutscher Verkehr-sunternehmen, 2007). Within the existing regulatory framework,competitors may outbid each other in CCL procedures (resultingin an English auction design; see Recker, 2007, p. 71, and Beck,2007, pp. 426–429). Notwithstanding the current framework, anauction design based on the first-price auction method, as wassuggested by the Proposal (see BMVBS, 2008, p. 4), will beassumed for CCL procedures as well.

CCL procedures will be executed by LAs, while PTAs will beresponsible for tendering procedures. The minimum quality levelmq to be delivered by operators, as required in the PTP, is a fixedquantity at the beginning of the analysis that is set by PTAs.

The fare revenue risk is borne by the operator. For this reason,public service contracts which will be used in case of tenderingare classified as net cost contracts. We assume that the level offares (the prices for tickets) will be set by all members of aVerkehrsverbund, which is one of their main tasks in Germany(see Knieps, 2004, p. 80). For simplicity, prices (or fare levels) aretherefore determined exogenously.

Subsidies for fare reduction (SFR) – e.g., compensations forpupils and the disabled, as well as supplementary direct subsidiesclassified as other operational revenues (OR) – will be equal and

ing procedures were observed See also Beck (2010, 2011) for detailed insights into

these databases.15 Within the real German public bus transport market only a very small

market share has been exposed to competition so far.

C(q)

FR(q)x‘‘

By‘‘

x‘

A y‘x

ya

qz z‘ z‘‘TA TB

virtualnon-com-

mercial withπ(mq) < 0

commercialwith

non-com-mercial with

π(mq) ≥ 0 π(mq) < 0

Fig. 3. Commercial and non-commercial services from an operator point of view.

A. Beck / Transport Policy 19 (2012) 26–35 31

fixed for all operators so they can be normalized to zero. All other(remaining) supplementary direct subsidies (SDS) necessaryto sustain the level of service with the minimum quality levelmq will be net subsidies from an operator point of view.

The cost function (C) will be the same for all operators (all C

are assumed to be identical).16 Costs depend on the (quantity of)quality q offered (C(q)) and C shows a convex shape. The quantityof quality may be, for example, the scheduled frequency. Therewill be fixed costs (e.g., for building a bus depot, buying vehicles,etc.) on the level a. The cost function will be C(q)¼aþb(q) where@C(q)/@q40 and @C2(q)/@q40.

The real sum of all fare revenues to be generated by theoperator out of a specific license depends on the quantity ofquality delivered by the operator (FR(q)). For simplicity, weassume a linear shape where @FR(q)/@q40 and @FR2(q)/@q¼0.

Expectations about fare revenues E[FR(q)] (based on expecta-tions about elasticity with respect to quality)17 may differ formarket participants due to different levels of information.

Profits (p) for operators are p(q)¼(FR(q)þSFRþOR)�C(q)¼FR(q)�C(q). Due to perfect competition, in equilibrium, profits foroperators are p¼0. Operators will enter the market (and submitan offer for the specific services) as long as they expect pZ0 to bethe participation constraint for these auction procedures.

Source: own figure.

4. Market participants’ opportunities for action

4.1. The distinction between commercial and non-commercial

services

If, initially, q¼mq (with, e.g., mq¼z, as seen in the first intervalin Fig. 3) and p(mq)o0, the level of mq is too low to becommercially feasible for operators. Fare revenues FR(mq) willnot cover costs C(mq) here. Nevertheless, operators are free toincrease their quality offered (q) to reach a level which iscommercially feasible with p(q)Z0. This first interval, whereservices are ‘‘virtually’’ non-commercial, is not stable. It willtherefore not be discussed.

If initially, q¼mq (with, e.g., mq¼z0, as seen in the secondinterval in Fig. 3) and p(mq)Z0, the level of mq is commerciallyfeasible for operators from the outset. Supplementary directsubsidies are not necessary here. These services must be classifiedas commercial. According to the specific institutional framework,operators must participate in a CCL procedure for the right ofexclusivity. Assuming for simplicity a perfect auction (perfectcompetition with n-N bidders and no profits), operators musttransfer their full ‘‘potential profit’’ p(mq)40 (if existing) to anadvanced level of quality q4mq as long as pZ0.18 For example, ifPTAs determine mq to be z0, operators will transfer p(mq)¼x0–y0

to an advanced level of quality q until p(q)¼0 (being point B inFig. 3).19 Point A then represents the operator’s threshold whereservices become commercial on a level of q¼TA. Point B repre-sents the threshold where services become non-commercial dueto a relatively high level of q¼mqZTB.

If, initially, q¼mq (with, e.g., mq¼z00, as seen in the thirdinterval in Fig. 3), and p(mq)o0 as well as p(q)o0 for anyq4mq, the level of mq is too high to be commercially feasible for

16 This assumption is based on neoclassical economics. In reality, inefficiencies

must be assumed.17 The elasticity of passengers for a specific license with respect to the

quantity of quality is given by nature and therefore set exogenously.18 Setting up this as a maximization problem from an operator’s point of view:

max q such that p(q)¼0.19 If no competitive application is expected by the incumbent, a maximization

of p(mq)¼x0 – y0 has to be assumed which will then result in a quantity of quality

q¼z0oTB only (the result to be expected within a monopolistic market).

operators. Production costs C(mq) for the specific quality require-ments as defined by the PTA are too high to be covered by thesum of the fare revenue potential FR(mq) for the specific qualitylevel mq.20 Therefore, the services must be classified as (real) non-commercial services. Operators are not able to increase theirquality q to reach a level that is commercially feasible withp(q)Z0. If PTAs set mq on the level z00, supplementary directsubsidies SDS(mq)¼x00 �y00 are necessary to enable delivering theservices without deficits.

Profits for operators are then p(mq)¼FR(mq)þSDS(mq)�C(mq)Z0. Generally speaking, in the case of non-commercialservices they will (have to) receive supplementary direct sub-sidies on the level SDS(mq)¼C(mq)�FR(mq)40.

From a PTA point of view, the amount of SDS(mq) necessary toenable the delivery of non-commercial services is the sum ofpayments necessary to compensate operators for the deficitsresulting out of the obligation to deliver a quantity of qualityhigher than commercially feasible. These compensation payments(CP) in favor of the operator will charge the PTA’s budget with avalue of �CP(mq)¼SDS(mq). The three-dimensional Fig. 4 sketchesthe relation between commercial and non-commercial services withrespect to CP (simplification assumption for Fig. 4: CP(mq) and q arelinear) from a PTA point of view.

As shown in Fig. 4, the main characteristic of non-commercialservices is that the level of quality q¼mq requires compensationpayments CP(mq)o0 in charge of the PTA (see, for example, pointD). To win the awarding procedure, operators must submit offersbased on a minimization of SDS(mq).

If q¼mq and CP(mq)Z0, these services can be classified ascommercial. At the threshold TB, services will become commercialwith CP(mq)¼0. Here, the quality offered by an operator will beq¼mq.

If FR(mq)4C(mq), operators will be able to pay a franchise feefor the right of exclusivity to operate the specific services for thelicense term (see, for example, point E). With respect to Fig. 3, thisfranchise fee can be in the amount of CP(mq)¼x0–y0 for mq¼z040.Despite this potential to solve budgetary problems, the German

20 In other words: the level of q that is commercially viable for operators

without payments from PTAs is qomq.

Franchise fee infavour of PTAsbudget(CP(mq) > 0)

Quality level q offered byoperator exceeding mq

Potential for qualityincreases by operator inaddition to minimum qualitylevel mq(with q > mq)

E qE

mqq ’

FLevel of fare revenues FR(q)

TB with CP(mq) = 0CP(mq)

D

Compensationcharging PTAsbudget(CP(mq) < 0)

non-commercialwith CP(mq) < 0

commercialwith CP(mq) > 0

Fig. 4. Interaction of commercial and non-commercial services from a PTA point of view. Source: own figure.

A. Beck / Transport Policy 19 (2012) 26–3532

market organization for commercial services effectively requiresoperators to raise their quality level q which they offer to win theauction procedure, until CP(q0)¼0 with q¼q04mq instead.21

Quality competition then leads to a maximization of the addi-tional quantity of quality qa

¼q0–mq from a PTA (and passenger)point of view.

4.2. Effects of commercial services for market participants

It might be interesting to investigate the franchise fee CP40operators would pay for a license to operate a specific (commercial)service on a quality level q¼mq under exclusivity instead oforganizing a quality competition. PTAs would then be able toexpend the fees for cross-subsidies for non-commercial servicesand/or for general budget purposes.22 Given a specific level of mq,it would lead to a maximization of the single-dimension criteriaCP(mq) by operators. In contrast, the German institutional frame-work in force at the beginning of 2009 leads to a maximization ofa multi-dimension criteria q. In the case of mqoTB, operators willthen offer an additional qa

¼TB–mq. Nevertheless, in the case ofcommercial services this specific framework protects a specificlevel of quality q04mq for passengers instead of minimizing debtsfor PTAs.

The current regulatory framework enables operators to deter-mine qa on their own (and according to market needs). Thedetermination of qa is based on marginal revenues with respectto q as expected by operators and marginal costs with respect toquality. Therefore, the level of freedom for operators to design the

21 This regulation to increase quality instead of paying a franchise fee poses a

contrast to some, e.g., British railway franchises (see Nash and Smith, 2006,

p. 3 and p. 9), where in such a case, operators pay a franchise fee to PTAs.22 Please note that the framework as of 2009 already permits PTAs to

assemble non-commercial and commercial lines within one bundle (network) in

order to secure or enable cross-subsidization within this network (but without

any possibility to obtain a franchise fee). The license for this network must still be

classified as either non-commercial or commercial.

service is higher within the market for commercial services23

than within tendering procedures, where gross cost contractswith a detailed service specification are generally used.24 Opera-tors are able, to some extent, to bridge the gap if PTAs are notputting much effort into the determination of a high level of mq

within their local public transport network.PTAs which do not want to be involved in public transport via a

public service contract may prefer commercial services, enablingthem to avoid the need to conduct a tendering procedure, controlthe quality delivered, and settle accounts. A further aim might be toavoid financial risks such as energy price risk (see van de Velde et al.,2008a, pp. 59–65 and 2008b, pp. 62–63), which are usually coveredby PTAs via a public service contract. On the other hand, licenses forcommercial services will hinder PTAs from controlling servicesbased on a contractual relationship25 in order to secure a level ofservice in line with their own interests.

4.3. The challenge of different expectations

Within the existing institutional framework, the critical factor forwhether services have to be determined as commercial or non-commercial from a market participant’s point of view is the level oftheir expectations of revenues at or around the threshold TB with agiven q¼mq. Market participants will need to calculate the max-imum revenues they expect to be generated out of the specificlicense. The results may differ between operators (o) and PTAs. It ispossible that Eo[FR(mq)]aEPTA[FR(mq)] and therefore Eo[CP(mq)]aEPTA[CP(mq)].

23 See van de Velde et al. (2008b, pp. 31–33) for an example. Some selected

German PTAs also have used net cost contracts with less detailed service

specifications. Nevertheless, these are still more detailed than most of the PTPs

observed on the German public transport.24 See van de Velde et al. (2008a, pp. 51–56) and van de Velde et al. (2008b,

pp. 25–27, pp. 49–52, pp. 62–64, pp. 83–85) for case studies of these tendering

procedures from London, Stockholm, and some German cities.25 See van de Velde et al. (2008a, pp. 72–80) for an overview of possible

instruments, pros and cons, and case studies.

TB with mq0

z’ with mq’’z’’ with mq’’

FR(q)

CP

(mq)

< 0

non-com-mercial withCP(mq) < 0

commercialwith CP(mq) > 0

Fig. 5. Break-even-point from a PTA point of view. Source: own figure.

A. Beck / Transport Policy 19 (2012) 26–35 33

Different prospects for passenger reactions to q can be classi-fied as usual market developments, but some problems remain.For example, operators will anticipate a different model of marketorganization (commercial or non-commercial) than authorities.Even market participants’ expectations about the awarding pro-cedure (quality versus price competition, market versus authorityinitiative) and the contractual relationship (license betweenoperator and LA only, or additional direct public service contractbetween PTA and operator) may differ.

If operators’ expectations are Eo[CP(mq)]Z0 and PTAs expec-tations are EPTA[CP(mq)]o0, this is positive from a budgetaryperspective. But PTAs may have developed a public servicecontract and initiated a tendering procedure several months inadvance (usually costly and time consuming, see VDV, 2007).

An analysis of 117 CCL cases with start of operations in theperiod 2003–2008 shows that 31% of the 70 market initiatives haddifferent expectations with Eo[CP(mq)]rEPTA[CP(mq)]. Originally,they were tendering procedures initiated by PTAs, and the majorityoccurred in the state of Hesse, which decided to categorize all publictransport services as non-commercial (see Beck, 2009b). Wherelarge differences were found between Eo and EPTA, the PTAs mighthave been interested in increasing mq instead. Possibly theyfacilitated a quality increase on specific criteria that were unprofi-table for operators (e.g., services during evening hours), but also notfinancially feasible for the PTAs due to budgetary constraints.

In the case of Eo[CP(mq)]o0 and EPTA[CP(mq)]Z0, if PTAs failto initiate a tendering procedure early enough, problems willarise, such as carrying out a formal tendering procedure withsufficient time frames that allows bidders to develop well-calculated bids and enabling the winner to adequately preparefor starting operations. Note that VDV, (2007) recommends a totalperiod of almost two years to organize a smooth procedure forGerman authorities and operators. In contrast, applications tooperate commercial services are usually submitted by operatorsonly a few months before the start of operations.

4.4. The threshold as a break-even point for PTAs

Fig. 5 focuses on the threshold with CP(mq0)¼0, where allrevenues are expected to balance operational costs for theminimum level of quality (point TB with FR(mq0)¼C(mq0)). For aPTA, this is the break-even point. Starting with mq0, the decisionregarding the level of mq determines whether subsidies arenecessary (non-commercial lines with mqz004mq0, e.g., point z00),or not (commercial lines with mq0omq0, e.g., point z0).

Generally speaking, if PTAs decrease or increase mq for aspecific service, ceteris paribus, these services are more likely tobe commercial or non-commercial, respectively. Setting mq thendetermines the difference between the level of services of generalinterest in a controlled competition regime and what might becommercially possible in a free market regime.

Given that Eo[CP(mq)] is at least similar to EPTA[CP(mq)], PTAs areable to influence the market organization (commercial or non-commercial) to be selected for their services within this institutionalframework. Political decisions with respect to the level of services ofgeneral interest to be provided (level of mq), the level of directinfluence on services wanted (with or without a direct contractualrelationship between the PTA and operator) and budgetary con-straints26 are expected to impact their efforts in this matter. Thehypothesis that local parameters with respect to costs and revenuesare the only criteria allowing an efficient, competitive bus operator

26 Treasurers, for example, are able to ‘‘optimize’’ mq with the aim of

minimizing CP(mq) before any tendering procedure for non-commercial services

has to be initiated.

to deliver public transport bus services in a commercial way(commercial services as ‘‘given by nature’’) must be rebutted.

In fact, operators might welcome the existence of bothcommercial and non-commercial services within one marketsince it could provide them with a greater variety of businessopportunities. However, a conscious decision regarding mq isnecessary to provide clarity for operators about the market modelto be expected. Questions arise whether sufficient analyticalcapabilities are in place within PTAs, although they are compul-sory to avoid undesired side-effects at the threshold.

5. Conclusion

The study has analyzed the institutional framework forGerman public transport services by bus and whether the classi-fication of a specific service as commercial or non-commercialdepends on the local conditions and the scale of costs andrevenues in isolation. The results show that the level of minimumquality standards imposed on operators is also a decisive para-meter. This level is set by public transport authorities, which thusexert a major influence on the classification of services ascommercial or non-commercial. If they decide to decrease orincrease the minimum quality standards for a specific service,ceteris paribus, the services are more likely to be commercial ornon-commercial, respectively.

The survey of the commercial and non-commercial servicesexisting together underscores doubts about the feasibility andease of using this system. This applies especially to a marketorganization and an awarding procedure that differs fundamentallyfrom one kind of service to the other. Thus, clear classification ofservices is important for operators and authorities when developingtheir market strategies. The potential for uncertainty identified atthe threshold is one of the main pitfalls of this system.

A. Beck / Transport Policy 19 (2012) 26–3534

Nevertheless, the current framework enables operators tobridge the gap if PTAs do not put sufficient effort into their localpublic transport and/or if the sum of fare revenues is high enoughto enable commercial services. This possibility for operators to beinvolved in the market for commercial services represents animportant advantage of the existing framework: based on theminimum quality level, operators are free to attract new customersfor public transport (and increase profits) via their entrepreneurialsearch for better solutions. The co-existence of commercial and non-commercial services then becomes a tool for PTAs to organize theirlocal markets according to their own aims.

From a policy (and theoretical) perspective, an interesting ques-tion is whether the co-existence between commercial and non-commercial services in Germany, with different forms of marketentrance and market organization, is favorable to a market wherethe licenses for commercial services are awarded only after paying afranchise fee. A comparison to truly free market regimes, where theestablishment of services is initiated by operators only, or tomarkets where services are tendered only are interesting subjectsfor further investigation. A third comparison between commercialand non-commercial services would be useful as well.

A potential problem, however, may be the question of theoverall criteria valid for the assessment. While the decisioncriterion for operators is profit, usually in combination with apreference for entrepreneurial freedom, it is heterogeneous forPTAs. Here, the difficulty of optimization arises from the combi-nation of the (minimum) quality level and budgetary effects thatpoliticians want to achieve. Further (political) constraints oncontractual relationships (aspects of control), risk, and entrepre-neurial freedom granted to operators may also be relevant. Only acomprehensive welfare analysis based on all relevant criteria canprovide conclusive results about which market model is prefer-able. With respect to the multidimensional criteria mentionedabove, this analysis of the optimization potential for PTAs will bea challenging task for future research.

Acknowledgments

This paper is a product of the research done at the KarlsruheInstitute for Technology (KIT), Institute for Economic Policy Research(IWW), Department for Network Economics. I thank all discussionpartners throughout the research phase, in particular MathiasWalter from the Chair of Energy Economics and Public SectorManagement at Dresden University of Technology, Markus Ksollfrom the operator Deutsche Bahn AG, Rainer Peters from theauthority Landesnahverkehrsgesellschaft Niedersachsen, Peter Kainfrom the Federal Bureau of Infrastructure, Transport and RegionalEconomics of Australia, Sascha Frohwerk from the University ofPotsdam, Department of Economics, Mirko Schnell, Mathias Lahr-mann, Chris Knowles and Anna Lutterbach, my former colleagues atBSL Management Consultants (Lloyd’s Register Group), MelanieOertel, my former colleague at the consultancy KCW, and GerritLandsberg from the lawyers BBG and Partner for discussions. Specialthanks go to Kay Mitusch from the Karlsruhe Institute for Technol-ogy (KIT), Institute for Economic Policy Research (IWW), Depart-ment for Network Economics, for his critical remarks and AndreasBrenck from the IGES Institute for his very important comments andsuggestions on different versions of the paper. Without theirsupport, this paper would not have been possible.

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(EC) No. 1370/2007: Regulation (EC) No. 1370/2007 of the European Parliamentand of the Council of October 23, 2007 on public passenger transport servicesby rail and by road and repealing Council Regulations (EEC) Nos. 1191/69 and1107/70, published in the Official Journal L 315/1, 3/12/2007.

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Law on the Regionalisation of Public Transport (Regionalisierungsgesetz—RegG):Law as amended and promulgated on December 27, 1993 (see BGBl. I, 2378,2395), last amended by article 1 of the law from December 12, 2007 (see BGBl. I,2871).

Local Authority Traffic Financing Act (Gemeindeverkehrsfinanzierungsge-setz—GVFG): Law as amended and promulgated on January 28, 1988(see BGBl. I, 101), last amended by article 4 of the law from December 22,2008 (see BGBl. I, 2986).

Ninth Code of Social Law (Neuntes Buch Sozialgesetzbuch – Rehabilitation undTeilhabe behinderter Menschen – SGB IX): Article 1 of the law as of June 19,2001 (see BGBl. I, 1046), last amended by article 5 of the December 22, 2008law (see BGBl. I, 2959).

Official German Contracting Terms for Award of Service Performance Contracts,Part A (Verdingungsordnung fur Leistungen, Teil A—VOL/A): Revised versionpublished in the Bundesanzeiger 58 (100a) May 30, 2006.

Passenger Transport Act (Personenbeforderungsgesetz—PBefG): Law as amendedand promulgated August 8, 1990 (see BGBl. I, 1690), last amended by article 27of the September 7, 2007 law (see BGBl. I, 2246).

Glossary

Application or application form (Genehmigungsantrag): Offer or request by anoperator as an applicant to operate commercial or non-commercial services ona specific line or network bundle filed with the licensing authority using aspecific application form (see website under Bezirksregierung Detmold 2008in the references for an example);

CCL—competition for commercial lines or services (Genehmigungswettbewerb):Situation where at least two operators file an application for licenses forcommercial services;

Commercial lines or services (Eigenwirtschaftliche Verkehre): Operating costs forthese services are covered by fare and other operational revenues (see y 13PBefG);

Competition for non-commercial lines or services: PTAs have the obligation to awardsubsidies for non-commercial services at the lowest cost possible (see yy 8(4) and 13a PBefG); PTAs are allowed to award their supplementary directsubsidies through tendering procedures (Ausschreibungswettbewerb) similarto the procedures conducted in Denmark or Sweden;

Exclusivity: If a new application to operate a bus line competes with existingpublic transport services, and the operators of the existing lines claimconvincingly that the profitability of these services is jeopardized the licensingauthority must reject the new application; in reality this has resulted in astatus of more or less exclusivity for holders of existing licenses (incumbentoperators);

German Law on the Regionalization of Public Transport (Regionalisierungsgesetz—-

RegG): Legal framework to regionalize and re-finance public transport;established during market reform in the mid-1990s;

Gross cost contract: Contract where the PTA bears the revenue risk;Incumbent: The operator possessing the existing (old) license to operate;Institutional or regulatory framework: Legal framework for the public transport

sector by bus as established at the national level (including the crucial lawsPBefG and RegG);

LA—licensing authority (Genehmigungsbehorde): This authority grants the licensesto the operators which apply for them; this authority is entrusted with theobligation to safeguard security of operation for passengers and to ensurecontinuous delivery of services;

License or license for public transport services (Genehmigung): Authorization tooperate public transport services as defined in the bid filed by the operator(application), and based on y 13 or y 13a PBefG; awarded by the licensingauthority and provides exclusivity (see above) to operators;

License term (Laufzeit der Genehmigung): The period the operator is authorized tooperate the services granted under the existing license;

Licensee (Genehmigungsinhaber): Operator holding a license to operate a specificline for the duration of the license term;

Local Authority Traffic Financing Act (Gemeindeverkehrsfinanzierungsge-setz—GVFG): The legal basis for subsidies paid by national, state, and localauthorities to support long-term investments in infrastructure and vehicles forpublic transport;

Market initiative: Initiative to operate services by operators;Market participants: PTAs, LAs and operators;Net cost contract: Contract where the operator bears the revenue risk;Non-commercial lines or services (Gemeinwirtschaftliche Verkehre): Operating

costs for these services are not covered by fares and other revenues;supplementary direct subsidies by the PTA are necessary to ensure anadequate level of these services (see y 13a PBefG);

Other operational revenues according to y 8 (4) PBefG (sonstige Unternehmen-sertrage im handelsrechtlichen Sinne): Direct or indirect subsidies granted bystate authorities for a specific purpose; not accounted as ‘‘subsidies’’ for non-commercial services;

Passenger Transport Act (Personenbeforderungsgesetz—PBefG): Legal basis fororganizing the German public transport market by bus;

Priority of commercial services: In case the licensing authority has two applicationsto operate a specific service or line, one commercial and the other non-commercial, it is mandatory to grant the license to the operator applying for acommercial license, see y 8 (4) PBefG;

Proposal: First (and, so far, only) official proposed amendments of the PBefG toamend the national legal framework to comply with the new EU regulation(EC) No. 1370/2007 which became effective on December 3, 2009 (see BMVBS2008);

PTA—public transport authority (Aufgabentrager): Authority responsible for secur-ing an adequate level of public transport services in its territory in accordancewith the provision for essential public services (‘‘Sicherung der Daseinsvor-sorge,’’ see y 1 RegG);

PTP—(local) public transport plan (Nahverkehrsplan): Plan set by PTAs forminimum quality standards (e.g., minimum frequency of service, junctions,vehicle standards such as air-conditioning and low-floor entry), and the goalsfor improving public transport in the near future within their territory;

Short distance services: Regularly operated lines of up to 50 km distance and/or onehour travelling time as defined in both y 2 RegG and y 8 (1) PBefG;

T—threshold: Point where all operational costs for the minimum level of quality asdefined by the PTA in its PTP are covered by fare and other operational revenues.