Route Contract (Gross Cost) / Financial Aspects

Financial Aspects
Financial objectives
Very often reform is undertaken for financial reasons and it’s likely that there will be considerable interest in ensuring that financial objectives are set and achieved.

At the highest level the objective is to try to achieve the best possible transport service for a given level of funding. The overall level of funding for public transport in a city is usually decided after several rounds of discussions in which various levels of service are compared with various funding levels. Ideally once a figure is set it can be used as a base for future years.

After the overall budget has been agreed, it is the responsibility of the authority to make wise use of its funds and set some internal objectives. These would include:

Controlling its own expenditures within budget.
Controlling the capital expenditures within budget.
Controlling the recurrent costs within budget.
Improving the financial performance of the entire bus network.
Ensuring proper execution of contracts by the bus operators.

Specific objectives which can be measured might include:

The cost recovery ratio of all services.
Average cost per km.
Average cost per place km.
Average revenue per km.

The cost recovery ratio might be set with an objective of increasing it from say 60% to 80% over a five-year period.

Many authorities make use of financial models to help them assess the financial position and forecast future costs in an effort to improve their ability to meet their objectives. For more information on objectives see additional benchmarks and indicators.

Key financial characteristics of gross-cost route-contracts

Route contracts imply that after the initial tender exercise there will be regular, mandatory re-tendering of routes.
Since the route contracts will last for about five-to-seven years, there is a need to agree in advance how to amend the unit costs for changes in underlying prices (e.g., fuel, labor and spare parts). This implies that the cost figures given in the bid document by the bidder must show itemized groups of costs according to the basis for increase over time. These will be determined by the regulator.
The operator should include an element for profit in his bid. This would normally be a fixed amount or a fixed percentage and would not be subject to adjustment over the life of the contract. Thus the authority does not get involved in having to agree to reasonable profit levels for the operator as would be the case in a longer-term arrangement for an area-contract system.
After the initial bid, the regulator would not normally have any access to the operating cost data of any of the operators.
Since the contract is gross cost the operator is not concerned with fares or fare increases. The regulator would, however, have full knowledge of all revenues.
Since the contract is gross cost, there is no need to apportion revenue to operators this avoids considerable work and debate. The only reason to do so would be for internal financial planning purposes.

The authority’s financial obligations
The authority is responsible for four major cost items

The running costs of the authority itself (e.g., staff, overheads and offices).
The capital investment program for works related to public transport that may be the authority’s responsibility (e.g., terminals, stops and shelters and bus lanes).
The ongoing maintenance and management of authority-owned infrastructure.
The obligations for payment to the operators under the gross cost contracts.

Spending limits
It’s very likely that the city will have a limit to the amount that it wishes to spend on public transport and it’s the authority’s job to prepare budgets for each of the major cost items listed above and reach agreement with the city. Ideally this budget should cover not just the coming financial year but also three-to-five years into the future to ensure that the city is aware of its ongoing commitment for expenditure on public transport.

Forecasting cost increases
Items 1) and 3) above are likely to be relatively stable, increasing gradually in line with general inflation and with the growth and aging of infrastructure under the authority’s control.

Item 2) could vary considerably from year-to-year depending on the need to construct major facilities. Usually these costs are longer-term projects and considerable time is needed for planning. As a result the financial implications are known well in advance.

Item 4) is the most complex of the cost items. In the initial stages of the reformed system, the authority will be involved in the transitional aspects of moving from the old system to the new one and preparing tender documents for existing and new routes.

Depending on how the transitional phase was handled, the authority may or may not have a good knowledge of the operating costs and revenues for each of the tendered routes or packages of routes. Despite this, the authority must prepare a budget setting out their estimate of the costs that will be submitted by the tenderers and also their estimates of revenue under the prevailing fares regime. Taken over the whole system this should provide the authority with an estimate of their financial obligations for the coming year or so and the extent to which they require funding to cover any shortfall in fare revenue.

Since the contracts will normally be for a period of at least five years and since the authority will be committed to maintaining the tendered routes for this period or providing the contractor with alternative routes, the authority’s financial obligations stretch over a period of at least five years. Within this time, however, as a result of wage inflation, changes to fuel costs, and other variables, it’s likely that in absolute terms the amounts paid to the operators will increase.

The authority must be able to forecast the increase in its commitments and ensure that the city agrees in a timely manner to either a) increase fares to maintain the financial obligation at some agreed level or b) increase the subsidy.

Financial models
Often the authority will develop financial models that are designed to examine future scenarios such as increases in fuel prices, increases in inflation rates and exchange-rate changes. This allows the authority to keep watch on its financial obligations.

The finance division of the authority must also ensure that they have sufficient manpower and procedures to make prompt payments to the operators. Usually there will be a fixed day within a billing period (e.g., bi-weekly or monthly), by which the operators must submit their claims for payment accompanied by statements of kilometers operated and any variations from the agreed schedules.

They should also note whether these variations were due to reasons beyond the control of the operator (e.g., unusual traffic congestion), or whether these were due to their own faults (e.g., non-availability of staff). The finance division of the authority must have procedures in place to deal with all these situations. For more information see costs.

Revenues
Under the gross-cost structure all revenues collected on and off bus are for the account of the authority. This means the authority must make every effort to ensure that all fares are collected and all income reported to it by the operators.

There are two ways of handling revenues. One is for the operator to collect the on bus revenue, bank it in their account and report the amount to the authority. In this case the authority deducts the amount the operator has retained from the amount he is due under the contract and pays the balance. The other approach is for the operator to count the money but transfer it all to the authority. In this case, the authority pays the operator the full amount of the contract.

Fraud
Under either system, the authority must set up a procedure to ensure that there is no fraud occurring at any point in the revenue trail. This implies ensuring that all fares are collected, all fare revenue is handed in to the company and that the company reports or hands over as appropriate all revenues to the authority.

Forecasting
Since the authority designs the routes and specifies the timetable and hours of service, it suggests they have made forecasts or estimates of ridership and, by extension, of revenue. One of the risks that the authority incurs under the gross cost arrangement — but not under net cost — is that ridership and revenue are lower than forecast. Since the agreement with the operator is likely to give him some protection against the authority reducing the scheduled kilometers (and thus his income) without compensation, it is the authority’s financial position that will suffer.

Conversely if the ridership forecast is much too low and demand is much higher than estimated, then there may be a need for more buses. If the service is loss making then each additional bus allocated to the route will lose money and again the authority’s financial position will suffer. Only where the additional ridership can be carried with the existing bus allocation does the authority stand to gain. For more information see funding sources.

Dispute resolution
A gross-cost route contract should also have provisions for resolving disputes. Negotiation, litigation and arbitration are the three primary ways to resolve disputes.

Duration
Most contracts specify that they will end at some predetermined date in the future (with or without the possibility of renewal) and that, in certain circumstances, they may end even earlier. In this respect a gross-cost route contract is no different than most contracts.