Area Contract (Net Cost) / Legal Aspects / Legal Instruments / Net-Cost Area-Contract / Payments

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

If the bus services are unprofitable, the bus operator retains all revenue received by it in the course of providing the bus services. The transport authority pays a predetermined amount established on the basis of the expected difference between the revenue to be collected and the estimated cost of providing the bus services.
If, however, the bus services are profitable, the transport authority is handed back a predetermined amount.

The bus operator carries both the revenue and the production cost risks. This is because the contract is based on a fixed payment, either in favor of the bus operator (in effect a subsidy) or in favor of the transport authority (in effect a royalty).

The payment is based on the bus operator’s best estimate of the difference between expected revenue and the expected cost to be incurred by him in providing the bus services. If the bus services are profitable, the revenue risk can be shared with the transport authority.

If, instead of handing the authority back a predetermined fixed amount, the contract may provide instead for a percentage of the revenue collected by the bus operator in the course of providing the bus services to be returned. Or all revenue collected above a predetermined level may be kept by the operator.

The payment by the transport authority of monies owed to the bus operator with regard to the predetermined fixed sum set in the contract (which will be significantly less than in a net-cost contract since the bus operator already retains the revenue collected by him in the course of providing the bus services) usually occur on a fixed date for each calendar month that the contract is in force.

There are many possibilities for the exact timing of the payment (beginning, middle or end of the month — in advance or arrears). Usually the main consideration for any preference one way or another in that respect has to do with the cash flow of the bus operator and to a lesser extent that of the transport authority.

Incentives
From the point of view of the transport authority there are several advantages to the predetermined fixed subsidy or royalty payments set in the contract — the full cost involved in providing the bus services specified in the net-cost area-contract is known in advance and can be properly budgeted. Where a competitive bidding process is involved in the award of the contract, the various bids can be easily compared.

On the other hand, the predetermined fixed subsidy or royalty payments set in the contract, while providing some incentive for the bus operator to expand services and increase the customer base for those services, and hence increase his revenue, provides little incentive with regard to the provision of better services.

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.