Optimal Pricing in Urban Bus Companies in India

Abstract

•Urban Bus Companies (UBCs) in India play an important role in providing mobility and accessibility to urban dwellers. However, they are unable to augment fleet due to lack of resources. •Currently, most of the UBCs are facing financial crisis; on an average, every kilometer operated by them results in a loss of around Rs. 4.27. During recent years, UBCs put together, recorded the loss of over Rs. 500 crores every year. •The objective of this study is twofold. First, it aims to suggest pricing policy for urban bus companies. Second, it aims to estimate the optimal prices for selected urban bus companies in India. •In line with above objectives, cost function for selected UBCs is estimated wherefrom returns to scale and marginal cost of production is estimated. Demand functions for each of the said UBCs are also estimated which provided estimates of price elasticities of demand. Using the information provided by cost and demand functions, a simulation exercise was undertaken in order to arrive at welfare maximizing and profit maximizing prices as well as welfare maximizing prices subject to financial constraint. A methodology for automatic fare revision is also suggested. •This analysis is based on information obtained from a sample of seven UBCs viz., Brihan Mumbai Electric Supply & Transport Undertaking (BEST), Bangalore Metropolitan Transport Corporation (BMTC), Ahmedabad Municipal Transport Service (AMTS), Pune Municipal Transport (PMT), Thane Municipal Transport Undertaking (TMTU), Pimpri Chinchwad Municipal Transport (PCMT) and Kolhapur Municipal Transport Undertaking (KMTU). •To compute the returns to scale and marginal cost of production in UBCs, a translog cost function is estimated jointly with factor share equations subject to required coefficient restrictions by using the method of Zellner's iterative technique. The cost function has been estimated by regressing operating cost on input factor prices, output (pass.-km) and time. •During recent years, all UBCs are experiencing economies of scale. Furthermore, returns to scale are higher for smaller UBCs than for larger ones. Basically, economies of scale involve a less than proportional increase in operating cost when output increases while all the input factor prices remain unchanged. •Since all UBCs are currently operating under increasing returns to scale, marginal cost of production is less than the corresponding average cost. Hence charging a price equal to marginal cost would lead to financial deficit even though it maximizes social welfare. •Analysis of fares in sample UBCs reveals that average fare, in terms of real monetary units, of all the UBCs has increased from 1997-98 to 2001-02. •Estimation of demand functions of sample UBCs reveals that all UBCs are facing relatively elastic demand i.e., percentage decline in passenger demand is higher than the increase in real fares. •Stage-wise demand analysis was also carried out using BEST as a case study. Analysis reveals that stage-wise price elasticities vary considerably. Almost 74% of the total passengers are traveling by BEST's ordinary services and more than 99% of the total passengers are traveling either by ordinary or by limited services. For the ordinary services, 94% of the passengers are traveling relatively shorter distances (upto 10 kms). Furthermore, 74% of the passengers traveled upto 5 kms only. The percentage of passengers traveling beyond 15 kms is indeed negligible (2.11% of the total). Therefore, BEST should focus on rationalizing the fares for its ordinary services, particularly over shorter distances (upto 10 kms). •Welfare-maximizing prices (marginal cost pricing) are financially sustainable only in the presence of government subsidy. In the event of government subsidy not forthcoming, UBCs should be allowed to charge according to second-best principles i.e., maximization of social welfare subject to budgetary constraints. •The prices charged by UBCs deviate from the ones which maximize social welfare. The minimum deviation of price from marginal cost is observed in the case of BMTC. •This deviation of price from marginal cost resulted in social welfare losses for all sample UBCs. During the year 2001-02, sub-optimal pricing resulted in social welfare losses of Rs. 6.24, 1.44, 20.60, 3.85, 12.79, 187.25 and 21.63 million for PMT, PCMT, AMTS, KMTU, TMTU, BEST and BMTC respectively. •A model for automatic fare revision has been suggested in the study. While contemplating fare revision, urban bus companies must ensure that they are charging optimal fares at the time of revision. Any model of fare revision starting from sub-optimal fares could lead the concerned bus company along a path of perpetual disequilibrium. A robust model of automatic fare revision attempts to pass on the hike in input factor prices to passengers assuming that current price charged by firm is optimal one. •UBCs could also envisage adoption of differential pricing mechanism such as charging different prices during peak period, off-peak period, peak-direction, off-peak direction etc. Justification of differential pricing for peak and off-peak passengers stems from the fact that marginal cost of production during peak exceeds that during off-peak. Charging peak and off-peak passengers prices equal to their respective marginal costs not only maximizes social welfare but also has potential to augment traffic revenue. •Finally, one should note that apart from formulating a rational fare strategy, UBCs in India should also focus on improving their productivity and efficiency so as to achieve cost reduction and thereby enhance their competitiveness. Optimal pricing strategy and efficiency enhancement measures should be viewed holistically.