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.