Area Contract (Gross Cost) / Legal and Regulatory Framework / Gross-Cost Area-Contract / Payments

Payments
Under a gross-cost area-contract there are two kinds of payments

The first one covers the monies to be paid by the transport authority to the bus operator to compensate him for the full cost of providing the bus services.
The second one covers the monies to be collected as revenue by the bus operator in the course of providing the bus services. They are immediately handed over to the transport authority since these monies legally belong to the transport authority under the terms of the contract.

Because all revenue derived from the provision of the bus services accrue to the account of the transport authority, the transport authority carries the revenue risk (i.e. the difference between the actual and the expected revenue).

The bus operator, on the other hand, carries the risk associated with the cost of providing the bus services (i.e. the difference between the real cost incurred by him in providing the bus services and what he has agreed in the contract to be satisfactory compensation for providing those services).

Cost payments to the bus operator
The bus operator, in a gross-cost area-contract, provides bus services to the public. He does not do this for free. However, unlike his counterparts under an unregulated entry system or a public monopoly system, he is not compensated for the provision of these services directly by passengers.

He is paid by the transport authority. The transport authority pays him the predetermined fixed sum set in the contract. The payment is meant to compensate him for the cost of providing the bus services. (See the costs section for details).

If the gross-cost area-contract is awarded through competitive bidding, the predetermined fixed sum set in the contract is in essence the bus operator’s offer during the competitive bidding process and the basis upon which he has been awarded the contract. In making his bid for the contract, the bus operator obviously has to consider his variable and fixed operating costs, profits, contingencies, etc. But all this is outside the contract itself.
The payment in the contract is fixed and certain, but often subject to:

Quarterly or yearly indexation based on the consumer price index or on an agreed-upon price index, which can include, for example, the consumer price index, fuel, and labor costs.
Periodic adjustments according to an agreed formula based on input costs or (less satisfactorily, because forecasts may be wrong) on a fixed determined amount.

Even without a set formula for indexation or periodic adjustments, the transport authority will usually offer some protection to the bus operator against a few specific situations such as unforeseen large cost changes in key items, such as the price of fuel.

The payment by the transport authority of monies owed to the bus operator with regard to the predetermined fixed sum set in the contract usually occurs on a fixed date for each month the contract is in force. There are many possibilities for the exact timing of the payment (start, mid, end of the month — in advance or arrears). Usually the main consideration has to do with the cash flow of the bus operator and to a lesser extent that of the transport authority.

Revenue payments to the transport authority
In a gross-cost area-contract, the revenue collected by the bus operator belongs to the transport authority. See funding sources for information about the various elements that make up revenue in urban bus transport.

The contract should specify, as part of its provisions pertaining to the bus operator’s revenue payments, that:

All revenue from ticket sales (on-vehicle, at kiosks, at offices, etc.) and any other source of revenue (e.g. advertising) is the sole property of the transport authority.
All revenue collected by the bus operator should be forwarded immediately and directly to the account of the transport authority.
The bus operator is fully responsible for collecting all revenue payable on the buses.
The bus operator must fully account for the revenue and provide all relevant information in that regard to the transport authority, in the required format and within the specified periods.
Negligent failure to protect or fully account for the revenue will give rise to penalties, including but not limited to the full repayment of all missing revenue.
Wilful failure to collect, protect or fully account for the revenue will be deemed sufficient grounds for early termination of the contract at the discretion of the transport authority.

Incentives
From the transport authority’s point of view there are several advantages and disadvantages to the predetermined-fixed-sum set in the gross-cost area-contract.

Advantages

The full cost involved in providing the bus services specified in the contract is known in advance and can be properly budgeted.
The bus operator’s income, if no indexation or periodic adjustments are provided for in the contract, remains static in spite of rising costs.
The various bids can be more easily compared (where a competitive bidding process is involved in awarding the contract).

Disadvantages

There is no incentive for the bus operator to expand services.
There is no incentive for the bus operator to increase the customer base for the services.
There is no incentive for the bus operator to provide better services. Whatever the level of performance, the predetermined fixed sum must be paid.

Many bus operators will not willingly accept the extra cost or management effort associated with providing more and better bus services. Some operators will try to avoid even basic costs. But bus operators can be motivated by two simple mechanisms:

Financial incentives (more for good performance, less for poor performance)
The threat of early contact termination

Given the drastic nature of early contract termination, contracts normally focus on financial incentives such as bonuses or penalties.

Bonuses — provide a positive incentive for the bus operator to perform better than the minimal requirements set out in the contract. However, the bus operator should not be rewarded for things he does not have to work for. For example, if the transport authority puts extensive bus priority measures in place, the bus operator should not get bonuses for improvements in operating speed or reliability resulting from the new bus priority system.
Penalties — provide a negative incentive for the bus operator not to perform below the minimal requirements set out in the contract. Financial penalties affect the bus operator’s profits. This will normally encourage the bus operator to seek to correct the causes of his below-standard performance.