Is higher quality always costly? Marginal costs of quality: Theory and application to railway punctuality

Abstract

In the railway sector, there has been much discussion about the costs of delays to passengers and their willingness-to-pay to reduce them. However, the cost of delays in the supply side of transport markets have received far less attention (Van Oort, 2016). This paper fills several gaps in the transport and railway literature by studying the relationship between the costs of railway supply and travel time reliability. First we articulate a generic theoretical framework for the relationship between costs and quality in railways, building on past contributions in other sectors and bringing together diverse and currently disconnected literatures. A key new element of the framework is the explicit introduction of the concepts of ‘marginal proactive cost’ and ‘marginal reactive cost’. Second, through the lens of this framework, we empirically study the relationship between the cost of passenger train operation companies (TOCs) in Great Britain (2011 to 2015) and the reliability of their services, thus producing the first estimates in the literature of the elasticity of train operating company cost with respect to train delays, and in turn marginal cost of reducing delays. We find that for most TOCs improving quality is costly but, for some, quality improvements would be associated with lower costs overall, indicating that some operators are on a sub-optimal portion of the cost-quality curve. The framework and analysis can be used to aid quality related decisions in the railways including the design of incentive regimes; and can also be applied to other cost-quality contexts, in and outside transportation.