Will Competition Bankrupt the European National Rail Companies?

» Competition on European lines, and the related separation of infrastructure from operations, could spell financial trouble for public companies like SNCF and Deutsche Bahn.

If the competition between Europe’s two largest national rail operators SNCF and Deutsche Bahn (DB) was to be expected, it didn’t seem like it would come down this hard.

Last week in an interview with the Financial Times Deutschland, Ulrich Homburg, head of passenger transport at DB, declared that he was readying a “bloody battle” with his French peers. With international rail services opening up to competition on the French market beginning next month, you would expect Germany’s huge rail operator to be confident in moving onto SNCF’s terrain. But Mr. Homburg is adamant that the fight won’t produce good results for the rail companies or, ultimately, customers. “In a war,” he argued, “there are no winners… It will leave deep traces on the balance sheets.”

If Mr. Ulrich’s reaction seems exaggerated, it may be more a reflection of his fear that SNCF’s TGV services, which have a great reputation both on the domestic and world markets, will attract more customers than his own ICE trains. SNCF has submitted plans to operate high-speed trains between Frankfurt and Berlin and Frankfurt and Hamburg between 2011 and 2016 using either its own workforce or that of its subsidiary Keolis, using a fleet of 35 new international-ready TGVs the company is planning to order soon. This move surprised DB, which has thus far declined interest in new international services operating in and out of France. But DB is working actively to plan new services to compete with SNCF-owned Eurostar on routes from Germany to the United Kingdom. Eurostar is in turn planning direct trains between London and Amsterdam.

The French national rail market remains closed to competition until 2012. The cooperation the two companies currently hold in managing routes between Paris and Germany, in which ICE trains run to Frankfurt and TGVs to Stuttgart, may be coming to an end. The fate of Railteam, the European rail alliance, is unclear. The broader profitability of the national companies is in question.

The immediate effect of the new competition on international routes from France and national routes in Germany (also planned in Italy by partially SNCF-owned NTV) is likely to be decreased fares on corridors where more than one operator provides rail services. Unlike the system in Japan, where six rail companies have monopolies on intercity rail services in the respective regions they serve, or that in the UK, where train operating companies hold franchises on specific routes, mainland European high-speed rail competition will mean more than one company competing on the same lines, similar to the way deregulated air service works.

Like with airlines, customers will acquire the ability to choose the cheapest fare from a series of options, especially on high-demand routes, something they currently lack because of national rail monopolies. Standard amenities will likely increase. In the short-term, these changes may seem good for the consumer.

But in the longer term, as argued by DB’s Mr. Homburg, competition could spell disaster for the European network, which is currently renowned for its high standards.

The biggest problem results from the European Union-mandated separation of infrastructure and operations. In the past, national rail companies like DB and SNCF managed their budgets so that profits from their unsubsidized high-speed lines went into subsidizing their own infrastructure work on corridors throughout the system, for high-speed and local trains; a relatively balanced budget throughout the system was mandated by the fact that the tracks and the trains were owned by the same people. If the affiliated government decided to expand investment in new rail services, it would have to make up the costs through the provision of some other source of revenue.

But by moving infrastructure ownership to new public authorities (such as RFF in France) while keeping rail services in the hand of the national operator, two budgets were created, both of which had to be balanced, but, essentially, not necessarily with each other. Fortunately, of course, European rail authorities have no current plans to privatize infrastructure. Experience in the United Kingdom and Taiwan indicates that that’s a bad idea. Still, if the infrastructure owner is asked by the government to invest in new high-speed lines, it has to find the means to do so; meanwhile, the train operator has an incentive to reduce costs, especially if it’s faced with direct competition resulting in lower fares. The demands of the infrastructure owner, in other words, are not necessarily aligned with those of the train operator. This could lead to a budgetary conflict of interest.

Even without competition, SNCF is already suffering from the consequences of losing control over the French rail infrastructure. Though SNCF profited massively in FY 2007 and 2008 because of significant returns from its TGV operations, the recession has put it in trouble. In the long-term, though, the bigger problem is RFF, which is dramatically increasing track use fees to pay for debt service on its huge expenditures on new high-speed rail corridors and on the maintenance of local lines, which cannot pay for themselves. RFF is planning to increase charges on SNCF’s high-speed track use by 145% in ten years, from less than one billion euros overall in 2005 to 2.2 billion euros in 2013, completely eliminating the billion-euro annual profit from TGV services. The effects of new competition will magnify the problem.

At the local level, the changes won’t be as serious, because commuter trains remain subsidized by the national and regional governments, and will be even if the operator chosen is private. Germany’s regional rail market, already opened to competition from companies such as Keolis, works more on the British standard, with monopolistic franchises sent out to operators on a corridor-by-corridor basis. Subsidies for these unprofitable lines will continue to be distributed. European labor laws make it difficult to envision many people losing their jobs when operators change hands — making it likely that for most routes, because of the annoyance of firing and rehiring engineers, the national rail operators will remain in charge.

But by opening the potentially very profitable high-speed markets to competition, the national rail operators, though still mostly owned by their respective governments, become pseudo-private in the manner in which they operate and are perceived. The result: the government cares more about keeping infrastructure expenditures in the black than ensuring the continued viability of high-speed rail operators. This is the inverse of what should be happening, because it could ultimately mean the bankrupting of national rail companies and vastly inferior service for users.

In whose interest? It will mean fewer labor rights for workers who have spent years working for better salaries and benefits but who now are required to compete with the less-protected employees of other companies. It will mean more service on the most popular routes from a host of companies but fewer operations on high-speed lines that attract a lower patronage. If fares decrease initially, higher track user fees will undoubtedly mean increased passenger costs in the longer term.

Having national rail companies remain in control of operations and infrastructure ensures a more stable equilibrium between costs and returns and provides a model that allows high-speed trains to subsidize other operations, but without going overboard. It allows an honest assessment of how far rail profits can go, and prevents the damaging effects of competition, such as its tendency to lower fares to unsustainable levels.

The government’s expectation that operating companies can pay for infrastructure costs, including new investments, is unrealistic. SNCF is demanding that France rethink this philosophy, as it’s currently stuck, wanting to finance the purchase of 300 new TGVs for mainline operations but unable to do so because of an insecurity that it will be able to profit in future years. DB is similarly insistent that the German government reassess the manner in which it has allowed competition to advance on the home turf — especially since intercity rail in that country is open whereas it won’t be in France for three more years.

The danger of increasing competition of the European market with the present separation of operations and infrastructure can’t be more clear: it could mean the destruction of the viability of the national rail companies, which have provided some of the most reliable, convenient, and comfortable service in the world. The benefits to customers are ambiguous at best. A rethinking of this process should be in order.

15 Comments | Leave a Reply »
  • Steve

    Excellent commentary! It is one of my fears that a similar structure will be pushed here in the USA, severing Amtrak from the infrastructure it uses. But as you pointed out, separating the infrastructure encourages ruinous competition and scheduling. Keep up the good work TransportPolitic!

  • Woody

    These developments in Europe may well be replicated in the US. The ideologues of the efficient market are like a cult, so sure that they are right.

    Meanwhile in the U.S., I don’t think we have begun to talk out loud about who gets the future profits on HSR lines and what to do with that money.

    Right now, if St Louis-Springfield-Normal-Chicago makes a little operating profit, that bucketful of black ink offsets a bucketful of red ink from Amtrak’s many money-losing routes. But if the St Louis-Chicago line is upgraded to 110 mph, cutting an hour from the timetable, and increasing the daily departures from five trains to eight or 10 frequencies each way, there could be a barrel of black ink earned there.

    Then who decides how to spend the new profits and where and when ? Must it go to support further upgrading the corridor to 220 mph? Or investing elsewhere in Illinois next, perhaps on the tracks to Carbondale? Or will Amtrak or the FRA decide to put the profits from St Louis-Chicago into a new service far away, say, Dallas-Houston?

    If Uncle Sam puts up half the money, or more, to build California’s HSR, will half the future operating profits flow to Amtrak? To the U.S. Treasury general fund and not to rail at all? Into the Surface Transportation Fund to pay for more highways? Or what?

  • The primary reason the EU forced Europe’s national railways to segregate infrastructure – a wholesale business – from train operations and retail sales is actually cross-border freight. Increased freight rail volume, especially for intermodal freight, could allow regulators to cap planned increases for trackage rights.

    As long as politicians recognize that *standard-speed* passenger rail is a public service that will never turn a profit, privatization of train operations can and should go ahead. Infrastructure operators will need subsidies to keep rural branch lines open. Train operators will need subsidies to run trains on them, as well as for commuter rail services.

    Allowing multiple companies to compete in the high speed rail business will bring down prices for medium-distance travel while improving service. However, it will also reduce profit margins, i.e. the ability to cross-subsidize loss-making services. Commercial operators will seek to discontinue the latter unless the taxpayer keeps chipping in.

    Privatization as such is actually a good idea, considering how overstaffed many national railways are in Europe. However, only a fool would argue that competition alone is going to somehow make standard-speed passenger rail profitable.

  • John W

    I wonder if DB will be compelled to include SNCF’s competing domestic German trains in its timetables? If not, there’s an opening for a multi-operator booking engine like the UK’s thetrainline.com as no one is going to want to check multiple websites to see what all the possible departures are. It’d be a shame, though, as DB’s website is first class.

  • eldondre

    I would agree that, national companies or not, separating infrastructure from the carriers is a bad idea. In fact, I’d prefer if passenger rail subsidies here were decoupled from Amtrak and made available so that freight companies had an interest in running them over their own tracks. no system is perfect but ownership of the tracks and services seems to work best. the very fact taht the infrastructure company is building new lines and charging higher fees to fund them (regardless of the service’s profitability) is very troubling. the idea here to split off the NEC wasn’t a bad one, but it’s main flaw was to split off the infrastructure. Splitting it off lock, stock, and barrel wouldn’t be a bad idea at all. Interesting to note that the Eruopean companies do exactly what Amtrak does, take money from it’s high (er) speed lines to subsidize money losing lines. the main difference being Amtrak has fewer profitable routes and and those that it has, are of lower quality

  • They went through this same traditional-marginalist-economics inspired “separation” in New South Wales, Australia, and it was a mess. Come to think of it, they separated network infrastructure from operating companies using that infrastructure in the California electricity market, in order to worship at the cult of the abstract market, and it all went horribly wrong with Enron.

    The argument in this piece is dead on target – the problem with the real world version of market being artificially constructed is that the financial success of the infrastructure company becomes walled off from the success of the operating companies in delivering transport benefits to passengers.

  • I would take DB’s statements about the evils of competition with a grain of salt. Monopolies fight to keep their privileges, even when they engage in profligate spending, such as JNR.

    The national rail companies are already pseudo-private in France and Germany, in the sense that they’re expected to run a profit; SNCF is also politically independent, the hallmark of good private sector service. Conversely, both SNCF and DB have hurt their service by trying to minimize costs, all while enjoying a monopoly on rail service. DB has skimped on maintenance for decades, leading to the Eschede disaster and this year’s recall of the Berlin S-Bahn’s rolling stock. SNCF took shortcuts with TGV station placements, creating unusable beet field stations.

    Splitting infrastructure from service won’t worsen the existing problems. If anything it could force DB to build better trains, since passengers will be able to choose the safer TGV.

  • @ Alon Levy –

    “DB has skimped on maintenance for decades”

    That’s a rather sweeping statement. Afaik, the skimping started just a few years ago when politicians decided they wanted to float shares in DB on the stock market. The exception was the Berlin S-Bahn, which was hemorraghing money. Still, skimping on safety is always a braindead idea.

    “leading to the Eschede disaster”

    Incorrect. Eschede was caused by a decision to retrofit perfectly good but stiff monoblock wheels on first-generation ICE trains with a design that featured a steel core, a rubber ring and a steel rim around that. The idea was to improve passenger comfort while the ICE ran on DB’s legacy tracks at 125mph. The damping ring was a proven concept in commuter rail operations, but it failed catastrophically in this high speed application. Since then, no-one anywhere in the world has been crazy enough to use anything other than monoblock wheels on high-speed trains.

  • Adirondacker12800

    The damping ring was a proven concept in commuter rail operations

    Proven to be a bad idea in commuter rail operations. DB continued to use them after their consultants advised them there might be a problem and a commuter agency using them warned them they failed earlier than expected.

  • The unusually long maintenance intervals for the ICE came long before DB floated shares on the market, and long before Eschede. They go back to when the ICE was developed in the 1980s.

  • Nathanael

    If the infrasctuture is kept in government hands, and the infrastructure manager charges appropriate track access fees, *eventually* the governments will notice that they simply have to subsidize the infrastructure manager directly, in large amounts, the same way they subsidize roads, and the scheme will start working.

    Note that Amtrak already operates on infrastructure owned by others through most of the country. Where this infrastructure is owned by state or local government agencies, it is usually maintained fairly well; where it is owned by private companies, they have traditionally done their best to mistreat Amtrak, though this attitude has changed at Norfolk Southern and BNSF.

  • Nathanael

    “I would agree that, national companies or not, separating infrastructure from the carriers is a bad idea”

    I’m actually not sure about that — the record shows that private “vertically integrated” railroads routinely played bookkeeping games where they underfunded their infrastructure. Separating it out may be a way to guarantee full funding for infrastructure, or at least to make it clear and obvious when it’s being neglected.

    The infrastructure *must* be publicly owned, and the carriers should probably remain publicly owned *too*. Administratively, however, it may make real sense to have them as separately accounted subdivisions.

  • Nathanael

    ‘They went through this same traditional-marginalist-economics inspired “separation” in New South Wales, Australia, and it was a mess.’
    Never heard that story — care to share?

    ‘Come to think of it, they separated network infrastructure from operating companies using that infrastructure in the California electricity market, in order to worship at the cult of the abstract market, and it all went horribly wrong with Enron.’
    They did it in NYS, too, and it’s working just fine….

    The key difference is that they did it right. The NYS market regulator didn’t just abandon regulation of electricity prices when they separated infrastructure costs from generation costs — they watch like a hawk for potentially manipulated prices, and they will step in and order fixed prices whenever they see a market failure.

    They’ve also been implementing a very slow rate transition — formerly the per-kilowatt charges were subsidizing the infrastructure *very* heavily, making a hidden subsidy for extending electric service to tiny rural hamlets, and a hidden penalty for efficiently located houses and industries. The shift to a larger fixed charge for connection and a smaller variable charge for generation is part of a slow scheme for redressing this balance, and should *eventually* lead to it being cheaper to put your house near a power plant than far away from it. (Reasonable, right?)

    “The argument in this piece is dead on target – the problem with the real world version of market being artificially constructed is that the financial success of the infrastructure company becomes walled off from the success of the operating companies in delivering transport benefits to passengers.”
    Well, if the appropriately-subsidized operating companies are paying the infrastructure company to provide appropriate levels of infrastructure — and the monopoly infrastructure company is both setting prices correctly *and* keeping its accounting honest — both big ifs — then it should be possible to make the success linked to the success in delivering transport benefits.

    The thing to avoid is a lunatic scheme like Railtrack. Network Rail in the UK appears to be performing tolerably.

  • Nathanael, what you say about state ownership of track doesn’t work too well. In terms of lost potential revenue, the worst problem for Amtrak isn’t the freight railroads; it’s Metro-North, with its ban on tilting and low speed limits on the New Haven Line.

    However, this is not a problem of separating infrastructure and operations. It’s a problem of running trains on the territory of another company, which prioritizes its own operations. The point of separate ownership is to avoid problems like this, so that tracks will be owned by a neutral company.

  • In my view competition will only bankrupt those who are weak. We saw a lot of manipulation and error in the trucking industry regarding this back in the 1990’s. A few giant faltering companies bought smaller successful companies, who only drained them of their resources, then bankrupted both. True competition – the kind that I deal with every day – only serves to benefit the consumer, at every level. Competition is never the REAL reason for bankruptcy – usually it’s from financial weakness due to mismanagement.

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