MSc in Business Economics/ International Business EconomicsBuses in Coketown
Hypothetical Case study: predatory/anticompetitive behaviour
Disclaimer: The following is entirely fictional. No reference is intended to any specific town or bus operator. The cost and revenue figures were totally made up. This case was written some time ago so the dates are a bit old by now!
Buses in Coketown
Complaint
The Comfy bus company of Coketown complained that the Bigboy bus company was engaging in predation, as it had entered the market on three of Comfy' s routes and on each occasion had reduced its fares to a point where neither Comfy nor Bigboy were making profits.
The only possible motive for doing this was to drive comfy out of the market so that Bigboy could enjoy a monopoly. It already had 20% of the UK bus passenger market more if you restricted the market to the busy urban routes which the company had targeted.
Nature of product - demand and supply
Background
Bus services were deregulated in October 1986 under the Transport Act 1985. Prior to this the bus industry had been exempt from the provisions of competition policy. Operators could now choose routes services frequency and fares without the prolonged submissions to the Traffic Commissioners which had previously been required.
Companies responded by increasing flexibility - in vehicle size, timetabling, and driver hours and remuneration systems. New companies were set up and profitable routes saw an increase in competition. The number of bus miles increased considerably passenger miles by a little.
Demand
Coketown is a medium-sized conurbation (population 500,000) in the "lungs of England". It has a railway line running East-West with a 20 minute service during peak hours, 30 minutes most of the day and hourly on weekends. Stops are roughly two miles apart.
The bus routes in question run from the North to the Centre, the South East to the Centre, and the West to the Centre along the main arterial roads, with minor detours for local shopping centres.
Demand has been steady over the last few years. Although car ownership has been increasing, tighter restrictions on parking in the Town Centre (including £1 minimum parking charge) means that "having a Comfy ride" is a common way of going into town for people on the bus routes. (See Table 1 below).
Table I: Modal split: January- February 1998
Percentages
How did you make your journey Into town today?
Home Sector / Bus / Car / Train / Other / TotalNorth / 48 / 40 / 2 / 10 / 100
East / 43 / 35 / 14 / 8 / 100
South / 49 / 38 / 1 / 12 / 100
West / 41 / 33 / 19 / 7 / 100
The same survey asked about responses to a possible price increase. The results are shown. in Table 2.
Table 2: Question on price sensitivity
To bus passengers: “If bus fares were 10% higher, how would you respond?”
No difference to behaviour84%
Fewer journeys to town5%
Switch to trains, cars, walking etc. 6%
Don't know5%
Finally, respondents who had a choice were asked about how they chose which company to ride with. Table 3 shows the responses.
Table 3: Choice of bus company
To bus passengers on competitive routes:
“How do you rate the following in your choice of bus company?”
V important Important Neutral Irrelevant
Frequency 20%55% 10% 15%
Whichever comes first 56% 35% 7% 2%
Fares 40% 41% 18% 1%
Season ticket holder 4% 4% 2% 90%
A minority of respondents said they preferred the Comfy buses because their familiar blue buses had been in town. a long time.
The market - prices
The entry of Bigboy was followed by clear evidence of price reductions. The price of every journey where Bigboy brought in competition fell in stages. Table 4 shows the history of the prices.
Table 4: Price of a 1-mile bus ride to town centre - competitive routes
Comfy Bigboy
Jan-98 75p n.a.
Feb-98 75p 70p
Mar-98 70p 65p
Apr-98 60p 60p
May-98 60p 55p
Jun-98 55p 50p
Jul-98 50p 50p
Aug-98 50p 50p
Sep-98 50p 50p
Oct-98 50p 50p
Nov-98 50p 50p
Dec-98 50p 50p
Jan-98 50p 50p
The market - costs
Comfy provided evidence on their cost structure, and this is summarised in Table 5. They reckoned that each bus required revenues of £20 per hour in order to cover its costs.
Table 5: Monthly running cost for a bus
Typical values
Days on road25
hours per day 10
Wages, etc. £1,950
Fuel £750
Maintenance £300
Overheads £500
Depreciation £1,500
______
Total £5,000
Revenues and profits
Although the new competition had increased total passenger journeys by around 10% this did not compensate for the increase in the number of buses. Load factors had declined, leading to a loss in revenue for the established firm
Table 6: Impact of competition on Comfy Bus Co
Revenues
Peak Old faresNew fares
50 hours@ £55 /hour £25 /hour
sub-total £2,750 £1,250
Off-peak
200 hours@£15 /hour£8 /hour
sub-total £3,000 £1,600
______
Total £5,750 /month £2,850 /month
Views of the parties
Comfy
Comfy claimed that Bigboy's actions were clearly predatory. Price was below the cost of production for an efficient operator. Bigboy had engaged m similar activity m other cities, which had the effect of driving out the existing operator, and this was the reason for Bigboy' s growth.
Predation was also shown in Bigboy' s tendency to raise fares once again after competition had been eliminated. The resulting profits gave Bigboy a "deep pocket" from which to cross-subsidise with predatory intent.
Even the payment system for drivers was predatory. Bigboy drivers were given a bonus related to their total takings and this made them aggressive m getting to busy bus stops first.
Finally, Bigboy were cream-sk1mmers. They employed part-time drivers for the peak period, when load factors were higher. As a result, the off-peak service was primarily provided by Comfy, which was now losing £12 per hour per bus.
Bigboy
Bigboy explained that Comfy did not understand the nature of competition, which meant "survival of the :fittest". Bigboy' s philosophy was to keep fares down, by greater efficiency, including more flexible employee contracts and higher loading factors. This was the cause of their success m other cities. On average, fares in real terms were now 5% less than previously where Bigboy had won the competition.
Customers were rightly sensitive to fare levels. Comfy had the advantage of an established reputation, so Bigboy needed to keep fares competitive in order to break into the market. They regretted as much as Comfy that fares had dropped so low, but an agreement on fares would bring them m to conflict with competition law, and Comfy had been instrumental in trying to prevent entry by undercutting Bigboy in April.
Bigboy estimated their losses at £15,000 per month over its Coketown operations, but saw this as necessary to '"breaking Comfy' s monopoly" (although the competition from other transport modes meant that buses would always be a competitive industry.) Bigboy's research indicated that Comfy were still carrying 55% of the passengers, despite the growing acceptance of Bigboy by Coketowners.
Although both companies were making losses, price was above the avoidable cost of production. Bigboy estimated that each additional passenger-mile increases costs (cleaning, wear-and tear, fuel for stopping and starting) by no more than 2.5p. Only when buses were full was it relevant to consider the costs of running an extra bus. Bigboy reckoned their monthly costs per bus were between 5 and 10% lower than Comfy's, as a result of their greater flexibility and experience in other cities. (For example, some drivers doubled as cleaners in the off-peak period.)
Views of other parties
The consumer transport group said they were alarmed at Bigboy's activities as it posed the threat of monopoly in bus services “which are essential for people on lower incomes". The reduction fares was welcome but though that bringing prices closer to marginal cost would improve the environment by reducing the number of cars on the road. Usage would improve and companies would find it more profitable than the current policy of high fares and low load factors.
Questions for consideration
1. What further information would you seek? (up to three items, in order of priority).
2. What is the relevant market or markets?
3. Is there dominance in this/these market(s)?
4. What evidence supports the charge of predation or other form of anti-competitive behaviour?
5. Is a remedy called for? If so, suggest some alternatives. Which do you prefer?
Presenters may wish to adopt the role of Comfy, Bigboy, the consumer group or the competition body.
John Cubbin © 1997,2001,2005
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