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Applying social marginal cost pricing in rail PPPs: Present state, drawbacks and
ways forward
Joo Bernardino
, Zden

ek H


, Carlos Marques
TIS.pt, Consultores em Transportes, Inovacao e Sistemas, S.A., Lisbon, Portugal
Transport Research Centre (CDV), Brno, Check Republic
Instituto Superior Tcnico (IST), Universidade Tcnica de Lisboa (UTL), Lisbon, Portugal
Social marginal cost pricing
Public-private partnerships
a b s t r a c t
The application of social marginal cost pricing (SMCP) in PPPs in the railway sector faces several chal-
lenges. We examine in detail the practical applicability of SMCP in railway PPPs from the perspectives of
cost accounting and effectiveness of SMCP towards the allocative efciency goal, addressing the likely
drawbacks in conciliating the welfare objectives of SMCP with the objectives of project nancing (cost
recovery) and value for money that justify the realization of PPPs. To this end, we combine theoretical
analysis with the observation of empirical results of a case study. We split the analysis per type of private
service provision, which can be for service operation or infrastructure management. For infrastructure
management, we recommend splitting the operator remuneration and the track access charges. For
service operation, we argue that the correct decision on source of funding of the service operator should
depend on the characteristics of the contract.
2010 Elsevier Ltd. All rights reserved.
1. Introduction
The application of social marginal cost pricing (SMCP) in PPPs in
the railway sector faces several particular challenges, related with
the nature of rail marginal costs, with the nature of centralized
planning and management of railway operations, and with the
various existing scopes for private involvement in railway provi-
sion. We analyse the most relevant issues and their possible
consequences to conciliation of SMCP with PPPs, and try to identify
practical ways to adopt what should be feasible and effective
approaches to the application of SMCP.
We start by reproducing reporting on trends and concrete
cases of deployment of PPPs in the rail sector in Europe and
proceed with a description of the social marginal costs involved
in this sector. Drawing from the particular features of railway
transport, we then examine in detail the practical applicability of
SMCP from the perspectives of effectiveness of SMCP towards the
allocative efciency goal, addressing also the likely drawbacks in
conciliating the welfare objectives of SMCP with the project
nancing (cost recovery) and value for money objectives that
justify the use of PPPs. To this end, we combine a theoretical
analysis with results of a case study of an urban railway line
linking the two sides of the Tagus River in the Lisbon area,
realized within the ENACT
2. PPPs in the railway sector
2.1. Types of private involvement in railways
Railways were, in its early times, mainly constructed and oper-
ated by the private sector. However, with time, it became clear that
network economies and reduced scope for competition put railways
in a situation where a pure market was not the most benecial
system, and States began to take over their construction and oper-
ation. More recently, governments started increasingly relying on
partnerships with the private sector for railway projects and
undertakings, using regulation to guarantee their appropriate
* Corresponding author. Tel.: 351 21 350 4400.
E-mail address: joao.bernardino@tis.pt (J. Bernardino).
The ENACT study was commissioned by the European Commission under the
6th Framework program. The study developed in the period 2006e2009 and was
led by Prof Rosrio Macrio (TIS.PT, Consultores em Transportes, Inovao e
Contents lists available at ScienceDirect
Research in Transportation Economics
j ournal homepage: www. el sevi er. com/ l ocat e/ ret rec
0739-8859/$ e see front matter 2010 Elsevier Ltd. All rights reserved.
Research in Transportation Economics 30 (2010) 59e73
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Since the recent unbundling of infrastructure network operation
and train service operation, private involvement in railway supply
can take two major forms:
Service operation
Infrastructure management
By private involvement in service operation we simply mean
that the provision of railway services is performed by a private
entity, which may or not own the assets e the rolling stock. Infra-
structure management involves the supply, maintenance and,
possibly, investment in railway infrastructure.
The rst type is regarded as the competitive portion of the
sector, where different private operators are expected to compete
for the provision of train services and compete for demand within
and outside the rail mode. This form of private involvement is
already commonly used, and its application at a successful rate has
been demonstrated under adequate regulatory frameworks.
It can be discussed whether private involvement in railway
service provision can be regarded as a publiceprivate partnership.
The term Public-Private Partnership (PPP) has been in general
use since the 1990s, yet there is no widely agreed single denition
or model of a PPP. In the 2003 European Commission Guidelines for
successful PublicePrivate Partnerships, the termof PPP was broadly
dened as a partnership between the public sector and the private
sector for the purpose of delivering a project or a service tradi-
tionally provided by the public sector. General characteristics of
PPP arrangements that are proposed in the ECs Green Paper on
PPPs (COM (2004) 327 nal) are the relatively long duration of the
relationship, the method of funding the project - in part from the
private sector - the important role of the economic operator, who
participates at different stages in the project, and the distribution of
risks between the public partner and the private partner. By this
account, simple franchises of railway service operation could be
regarded outside the PPP universe, since contract durations and
investments by the private party can be small and its participation
may be restricted to a single activity (service operation). None-
theless, private involvement in this area still poses important
questions as to its conciliation with SMCP, and therefore we include
service operation in our object of analysis.
Infrastructure management has less scope for competition, and
certainly no signicant scope for competition for demand. Still,
a few PPPs for infrastructure have been carried out in Europe. They
comprise both negative and positive outcomes, and the subject of
attribution of infrastructure management to a private party is still
subject to controversy (see e.g. Pollit & Smith, 2001; Vickerman,
2004). While the step back with network privatization in Great
Britain and failures in other sites represented a major drawback,
there are also cases that seem successful, and there is a set of new
rail infrastructure PPPs under preparation in Europe. It is still
uncertain whether this trend will prevail. For reference, in the
following section we present a set of full-scale, infrastructure build
and operate PPP experiences, in the European States.
2.2. Use of infrastructure PPPs in European states
2.2.1. Trends in the use of infrastructure PPPs
According to the OECD report on transport infrastructure
investment (OECD, 2008), PPP projects of the type seen in the road
sector are less prevalent as far as rail infrastructure is concerned.
This is perhaps due to the fact that rail is generally managed on
a network basis, and because railway operators are already typi-
cally at an arms length fromgovernment decision-making in many
countries, as a result of their organisational structures. Notwith-
standing, in all monitored countries there is a growing number of
PPP rail projects in the preparatory or realization phase. In most
cases, these ventures provide a special service that is somehow
differentiated from the rest of the network operation. In the
following pages we present some relevant examples.
2.2.2. Infrastructure PPPs in European States Austria. The example of PPP is the project Nordkettenbahn
(NKB) in Innsbruck. The project is realized by Strabag (Innsbrucker
Nordkettenbahn GmbH). The provider of the concession is NKB; the
daughter company Strabag hands over economic risks and cashes
for the nancing incomes. The total investment is 51 mil. EURO
(ENACT, 2008a). Great Britain. One example is the Channel Tunnel Rail Link
(CTRL). CTRL was launched in 1993, as the largest project under
private nance initiative, to connect London with the Channel
Tunnel, and therefore speed up travel time to Paris on the Eurostar.
The project was also an EU Trans-European Networks (TENs)
project. Revenue forecasts proved to be highly optimistic, resulting
in the British government having to backstop the concessionaire
with a loan guarantee. On the basis of this guarantee, in 2006 the
UK Ofce of National Statistics determined that the government
had a controlling interest over the projects parent company,
London & Continental Railways, which was thus reclassied as
a public non-nancial corporation.
In a similar vein, the Eurotunnel Group, created in 1986 to build
and operate the Channel Tunnel, has struggled with the initial debt
incurred for the project, which cost six times more than initially
Another example of private nance initiative is the PPP to
provide, maintain, renew and upgrade elements of the London
Underground metro system. This involves 3 separate 30-year
contracts for different elements of the work, with payments based
on performance, including bonuses for surpassing a given cap, and
penalties for not meeting it (OECD, 2008). Czech Republic. Currently in Czech republic there is not any
practical experience with realized PPP projects in the eld of the
railway transport. One project is under preparation, covering the
Upgrade of the Prague-Kladno railway line plus construction of
a railway connection to the Ruzyn e Airport. It features a combina-
tion of BOT/DBFO and operation and management contract, costing
around 500 million EURO and having a contract term of 30e40
years. Meanwhile the emphasis has been placed above all on the
legislation treatment of the mentioned activities.
The following legal provisions are under question:
e proposal of Law about publiceprivate partnerships (franchise
e proposal of Law about public orders;
e amendment of Law about estate of the congestion/scarcity and
its appearance in legal relationship;
e proposal of Law about budgetary rules. France. PPP funding is utilized in the railway transport
infrastructure in France. An example is the building and operation
railway Perpignan-Figueras Rail Concession. The main target of the
project is the reduction of time needed for the border crossing
between the two states and the reduction of the railway operation
on the French-Spanish border. The total investment is 1.1 thousand
million EURO. The private party is responsible for building and
operation of the railway during the time of 50 years. The public
sector, which also includes the government of Spain, ensures the
project design and a partial funding of 540 million EURO. The
J. Bernardino et al. / Research in Transportation Economics 30 (2010) 59e73 60
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railway construction has started in February 2004. The nalization
is planned in 2010. Germany. We mention two relevant projects in Germany in
the eld of railway infrastructure. The rst is the Freiberg-Holzhau
(Erzgebirgsstrecke), where a 31 km infrastructure is operated
privately since 2000, with a franchise agreement of 19 years and
investment costs of 8.8 million EURO.
Another example is the Heidekrautbahn, where the private
infrastructure operator manages a line of 34.4, with a franchise
agreement of 15 years and comprising investment costs of 17.3
million EURO. Italy. An example of PPP in Italy is the construction of La
Nuova Linea Metropolitana di Milano M5 by the Municipality of
Milan. The PPP is a DBFO, with the start date in 2007, a building
period of 5 years, investment costs amounted to 502 million EURO
and a Partner Agreement of 32 years. Netherlands. Another rail-based PPP, established in 1999, is
the Netherlands High-Speed Line (HSL) rail link between Antwerp
and Amsterdam, based on a 30-year concession. The concessionaire
is remunerated by government on the basis of a performance
agreement, which demands 99% compliance in order for the private
partner to receive its full payment, and there was no transfer of
demand risk (OECD, 2008). Sweden. PPP nancing in Sweden is used in the eld of the
railway infrastructure very often. For instance, we can mention the
project Arlanda. In return for paying for about 70% of the infra-
structure investment, the concessionaire is entitled to charge train
passengers both to pay for operating the train and in order to
recover the initial investment, over a period of 45 years. The
Arlanda contract assigns both market and cost risk to the conces-
sionaire. The Swedish government provides a guarantee loan to
the operator which is subordinate to all private debt; by postponing
interest and debt retirement until private debt has been repaid, this
results in a reduction of the companys costs for debt service during
its rst years of operation (OECD, 2008).
2.2.3. Prospects for infrastructure PPPs
As a conclusion, OECD (2008) remarks that these types of
examples largely demonstrate the fact that rail PPPs are likely to
focus on specic services or needs, as an adjunct to the larger
networks, which are also managed using devolution models, typi-
cally state-run or private organisations.
3. Social marginal costs in the railway sector
3.1. Social marginal costs in the railway sector
The main barriers to the introduction of social marginal cost
pricing in rail infrastructure are related with the difculties of its
measurement (especially for congestion and scarcity) and the fact
that they do not provide the right incentive for investments,
nancing and the transformation of railways into marketable
entities. Moreover, rail infrastructure managers have an aim to use
charging revenues to cover their total costs, or at least a greater
proportion of costs, than those covered through marginal cost
pricing. Rail cost categories and estimation methodologies are
discussed below.
3.1.1. Marginal cost of infrastructure
Available infrastructure cost accounts for the rail sector distin-
guish usually between the cost of operation and maintenance,
administration and overheads and the capital costs. A more detailed
cost categorization is certainly available inside the rail companies.
Furthermore, in the creditedebit balances costs are categorized.
However, there is no ofcial categorisation of variable and xed
costs. It shouldalsobe notedthat infrastructure cost accounts for the
rail sector have to deal with the problem of how to distinguish
between the costs of tracks in the narrow sense and those related
with other facilities such as stations and freight terminals (High
Level Group on Transport Infrastructure Charging, 1999a).
Moreover, the accounting systems currently applied by infra-
structure managers have not been designed with the scope of
setting charges. Therefore, a transition is needed towards more
elaborated accounting systems able to provide the adequate input
for cost models (activity based costing, life cycle costing, etc.) and
charging calculation procedures (marginal cost calculation)
(RAILCALC, 2007). Studies for estimating marginal infrastructure
costs have been carried out in Germany and Sweden. DB estimates
that 15%e20% of costs are variable costs. The Swedish analysis of
marginal maintenance costs (Joansson & Nilsson, 2002) has
empirically shown that 10% of the average costs for maintenance
are marginal costs, which implies that the share of marginal costs in
all average costs is even lower (Table 1) .
Railtrack, the previous owner of UK railway infrastructure, has
undertaken specic research for the structure of rail access charges.
Within this study asset usage costs (marginal costs of maintaining
and renewing assets) were estimated and indicated that the
proportion of Railtracks costs that vary with asset usage is around
10e15% (High Level Group on Transport Infrastructure Charging,
GRACE project case studies (Lindberg, 2006) performed esti-
mations on marginal costs in the rail sector. Estimations indicated
0.00070 /ton-km in Sweden for renewal and maintenance and
0.00097 /ton-km in Switzerland. Maintenance only has a cost of
0.00031 /ton-km in Sweden and 0.00045 /ton-km in
Switzerland. The marginal cost in UK is estimated in 0.002 /ton-
km. Operation has a marginal cost of 0.054 /train-km in Sweden.
The Hungarian study concludes on a marginal cost of 0.22 /train-
km for train movements.
When short-run marginal costs are calculated through econo-
metric analysis, the cost categories involved are operation, main-
tenance and renewal (or one or two among them). It can be argued
that most of the current experiences calculating short-run marginal
costs through econometric models sum up maintenance and
renewal costs as a single dependent variable. This practise is
generally justied by the short series of data currently available
that could be distorted by the long periodicity related to renewals
(RAILCALC, 2007).
NERA (1998) gives some guidelines about which cost elements
are relevant for deriving short-run marginal costs. These costs
relate to an existing non-congested rail network, and contain:
Table 1
Comparison of unit Activity Cost Inputs (current prices).
UK Cost (e000s)
Rail renewal (e/mile) 254
Sleeper renewal (e/mile) 486
Ballast renewal (e/mile) 501
Points renewal (e/mile) 181
Tamping (e/mile) 6
Rail repair (e/failure) 2
Points repair (e/failure) 10
Sweden Cost (e)
Track wear and tear (per gross km) 0,0003
Use of marshalling yards (per wagon, occasion) 0,4457
Source: Railtrack and Swedish National Rail Administration (edited in ENACT,
J. Bernardino et al. / Research in Transportation Economics 30 (2010) 59e73 61
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e Additional track wear and tear;
e Traction current;
e Signal operation costs;
e Train planning costs;
e Management and administration costs;
e Costs of disruption caused to other train services.
3.1.2. Marginal cost of congestion and scarcity
External costs in rail are generally small, except possibly those of
scarcity costs, which may be important depending on infrastruc-
ture capacity and demand. Existing evidence shows that scarcity is
indirectly included in some existing pricing schemes by consid-
ering demand or quality level of tracks or slots.
Estimation of congestion costs in rail is more complex than is
the case on roads or airports, due to complexity caused by networks
and schedules.
As reported by IMPACT (2007), the UNITE study suggests
marginal external congestion gures in rail transport is around 20
/train-km in morning peak based on UK and Swiss evidence.
However, the positive externality of additional demand (Mohring
effect) based on Swedish data is believed to be 5e10 times higher
than external rail congestion costs. Such low congestion costs
estimates are in line with the ndings of the COMPETE country
results, stating that congestion in rail transport is often eliminated
by respective adoptions of time tables.
The High Level Group on Infrastructure Charging (1999b) and
others suggest to better use the value that train operators put on
the scarcity of tracks as a measure of infrastructure capacity utili-
zation. In other words, scarcity costs should be valued by the
opportunity cost of the slot in question. Slot auctioning is thus
a possibility for valuing scarcity costs, but it may be rendered
difcult due to the complexities involved in terms of the alternative
ways in which the infrastructure may be used. Complementarily to
scarcity costs, it is suggested that unscheduled delays imposed by
one train operator on another may be charged ex post.
A different approach, recommended by NERA (1998), is to iden-
tify sections of infrastructure where capacity is constrained and to
charge the long run average incremental cost of expanding capacity,
although this is a very difcult concept to measure (Nash and
Matthews, 2002). An alternative approach considered in GRACE is
for the track charging authority to attempt to calculate directly the
costs involved in depriving another operator of the slot, for instance
through the value people place on departure time shifts. The GRACE
case study on the stretch of the East Coast Main Line fromLondon to
Doncaster shows that scarce tracks in peak hours might be over 10
times more valuable than tracks in off-peak (Lindberg, 2006).
Only Great Britain has a congestion charge per train-km
explicitly related to estimates of congestion costs. However,
charges per train-km in Italy and Germany vary by train speed and
type of route. In Germany there is an explicit utilization factor, with
a higher charge for heavily used lines. Italy uses a simple approach
of setting standard speed proles for each route designed to opti-
mise the line, and charging higher prices for paths that deviate
from the prole, either by seeking faster or slower paths that
disrupt the optimal service prole. Slovenia is proposing an off-
peak discount. There is also a charge per node in Switzerland and
Italy that varies with the implicit amount of congestion at the node
by categorizing nodes according to trafc levels (European
Conference of Ministers of Transport, 2005).
3.1.3. Marginal costs of environment
Air pollution and climate change costs of trains are negligible
compared to infrastructure costs, except for diesel trains. Air
pollution costs in /train-km passenger and freight trains (from
HEATCO and CAFE CBA cost factors for Germany used) vary
between around 0,1 and 0,6 /train-km for electric trains and 1,4 to
7,5 for diesel trains. Climate change costs vary between 0,03
/train-km and 0,55 /train-km, while diesel trains vary from 0,12
to 0,62 /train-km (IMPACT, 2007).
Noise emissions are dependent on train speed, the coach/wagon
type, surface conditions of both wheel and rail, and type of track
(including the level of maintenance). Closely related to these are
cost drivers like the type of brakes, the length of the train, and the
presence of noise walls (ENACT, 2007). Recommended output
values for rail noise are presented in Table 2.
3.1.4. Marginal cost of accidents
Few studies on marginal (or rather average) accident costs exist
for railways. In INFRAS/IWW (2004) average external accident
costs for rail transport are calculated based on up-to-date UIC
accident statistics. The Swiss case study within UNITE (UNITE,
2002) also presents values for average external accident costs for
rail transport. Costs for accidents between rail and other modes
are allocated based on a causation perspective (and therefore
mostly attributed to road transport). European average external
accident costs for rail transport amount to 0.08e0.30 /train-km
(IMPACT, 2007).
3.2. Are current charging practises in Europe compliant with SMCP?
Previous chapters of this special issue describe current charging
practises throughout European countries, including the railway
sector. As it shows, current infrastructure use charging practises
relate only partly with the principles of SMCP, with signicant
differences from country to country.
Marginal cost pricing is advocated with the aim of encouraging
efcient use of the railway network. However railways tendtoexhibit
economies of density and consequently the marginal cost of extra
network utilization is belowthe average cost. Thus, full cost recovery
cannot be achieved through (simple) marginal cost pricing. Two
alternative pricing principles are applied: marginal cost pricing with
mark-up (MC) and the pricing to recover full cost less government
grants (FC-) whichis appliedonly inGermanyandItaly, as we will see
in the following section. Both MC and FC- are aimed at full cost
recovery less government grants; however the MCapproach, being
basedonmarginal cost pricing, is viewed as less distorting interms of
incentives. Maintenance, renewals, train planning and operations,
congestion and scarcity, accidents and environmental costs are used
as the cost base to determine both social marginal cost and average
cost. No country charges for all of these categories but all countries,
Table 2
Unit values for noise marginal costs for different network types of rail trafc - (Eurocent/vkm).
Type of train Time of day Urban Suburban Rural
Passenger Day 23.65 (23.65e46.73) 20,61(10.43e20.61) 2,57 (1.30e2.57)
Night 77.99 34.40 4.29
Freight Day 41.93 (41.93e101.17) 40.06 (20.68e40.06) 5.00 (2.58e5.00)
Night 171.06 67.71 8.45
Central values in bold.
Source: ENACT (2008a), data aggregated from IMPACT, 2007.
J. Bernardino et al. / Research in Transportation Economics 30 (2010) 59e73 62
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except Italy, charge for maintenance expenditure. Some even charge
for trainplanningandoperations. Charges for congestionandscarcity,
accidents and environment are only undertaken by a minority of
countries. Inparticular, environmental/accident costs are included in
the charging methodology only inSweden, while scarcity/congestion
costs are taken into account in France and Germany (DIFFERENT,
The RAILCALC (2007) study assessed the extent to which current
accounting and charging practises are aligned with the objectives
and requirements mentioned in Directive 2001/14/EC on the allo-
cation of railway infrastructure capacity and the levying of charges
for the use of railway infrastructure (European Commission, 2001).
The analysis has specically focused on the aspects of cost recovery,
cost relatedness, incentives to cost reduction, differentiation
according to services, differentiation according to type of line,
consideration of demands willingness to pay, incentives to optimal
use of capacity and complexity.
The analytical procedure has been applied to various charging
elements identied as being used by railway infrastructure
managers, including cost of use of assets, mark-ups, reservation
charges, performance schemes, congestion charges, scarcity
charges, environmental charges and subsidies and discounts. The
following table (Table 3) synthesises the confrontation of cost of use
of assets (CUA), which are the predominant marginal costs for
railway infrastructure costs, with the objectives and requirements
of the Directive. The study identied fteen different basic charging
schemes related to the cost of use of assets practised throughout
European countries.
Part of the basic charging schemes identied was assessed as
having a positive alignment with SMCP related objectives and
requirements, although most had a negative judgement. Similar
analyses were performed for the remaining identied charging
elements used across Europe. Besides charges related to costs of use
of assets, the other types of charges found and analysed were mark-
ups, reservation charges, performance schemes, congestion
charges, scarcity charges, environmental charges and subsidies and
discounts, with differing results. An important observation of the
project was that the conciliation of all objectives and requirements
foreseen by legislation was not fully possible.
4. Applying SMCP on privately provided railways e from
theory to practice
4.1. Why may SMCP interfere with private involvement in railway
Like in other transport modes, social marginal cost pricing in
railways may interfere with private involvement in railway provi-
sion because it imposes a price, and the imposed price may not
function appropriately from various perspectives:
SMC price may not generate enough revenues to pay the
private operator
SMC price formation may introduce high risks of revenue, and
thereby become an impediment to private participation under
a reasonable compensation
SMC price formation may introduce undesirable incentives on
the performance of the private operator
These types of constraints have specicities in railways in
comparison with other transport sectors, specially due to differ-
ences in price structure and dynamics. They also differ with the
type of activity attributed to the private party.
Interference is only important if the operator is remunerated
through user charges. In face of the potential constraints imposed by
SMCP on private involvement in railway provision, it becomes clear
that important problems are only caused when the operator is paid
on the basis of user charges. Otherwise, SMCP will not have direct
inuence neither on the level of payments nor on revenue risks or
incentives to the private party (for a detailed presentation of the
argument, see ENACT, 2008b).
Exception to this rule may be if the private operator is remu-
nerated proportionally to demand (through a shadowtoll), a case in
which the price indirectly affects the operators funding by inu-
encing the demand level. Still, in this case, the effects should be
small and not necessarily undesirable.
Of course, the possibility of no interference of SMCP with private
involvement by splitting charging revenues from operator's
remuneration does not mean that undesirable nancing, risk and
incentive problems may not occur. They are, instead, transferred to
the public party. But this situation is not different in essence from
a situation where there is no private involvement, where revenue
drawbacks from SMCP affect the public party anyway.
As such, how may SMCP affect private involvement in each type of
activity? As we have seen above, private involvement in railway
provision may include two distinct types of activity: infrastructure
management and service operation. The way in which SMCP may
affect private involvement has different incidence in the two
activities, depending on funding mechanisms used and on SMC
charge formation considerations for each activity.
Section 4.2 describes the differences in framework on funding
and charging for the two types of activity e infrastructure
management and service operation. The following sections explore
more precisely how SMCP may affect private involvement, and
which ways forward are available to conciliate SMCP and private
interests in the involvement in railway operation.
Section 4.3 identies the factors of interference between SMCP
and private involvement, including nancing, risks and incentives.
Section 4.4 analyses these factors in more detail, in the scope of the
railway sector. Section 4.5 discusses possible ways forward to
conciliate SMCP with railway PPPs (separately for service operation
and infrastructure management), including analysis on different
Table 3
Confrontation of cost of use of assets with objectives and requirements of Directive 2011/14/EC.
CUA 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Economic efciency
Non-discriminatory access
Incentives to cost efciency
Cost-relatedness (CUA)
Differentation according to specicities
Uniformity of charging principles
Non discriminatory charges for different RU
Marginal cost approach
Relation between charges and costs attributable to infra services
Practices codes indicated in x5.8: () Positive alignment () Negative alignment.
Source: RAILCALC (2007).
J. Bernardino et al. / Research in Transportation Economics 30 (2010) 59e73 63
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nal user price formation schemes, identication of usable
contractual performance incentives and assessment of their need,
and a nal discussion on who should be the owner of SMC pricing
4.2. Funding and charging frameworks
4.2.1. Should railway service users be charged according to SMCP?
At least since the talks of the EC High Level Group on Transport
Infrastructure Charging (1999a), the framework of analysis on
social marginal cost pricing in all modes has been focused on infra-
structure charging, rather than charging for all infrastructure and
operation related costs. However, a recurrent theme of the discus-
sions in the group was the different nature of the customer treated
by a road infrastructure owner and a rail infrastructure owner
(Goodwin, 2001). Road customers consist of atomistic users - indi-
viduals or rms, while rail customers, following separation of track
and operations, are a small number of operating companies, so that
the relationship with the nal customer (i.e. the passengers) is more
In this scope, should rail passengers be charged according to
SMCP (and how)? The issue hasnt been discussed in depth because
the terms of reference of the Group focused explicitly on infra-
structure charging, rather than charging for all infrastructure and
operations. Yet, the question is of crucial relevancy in the rail sector,
not only for the issue of how to correctly introduce SMCP but also
for its implications towards conciliation of SMCP with private
involvement in rail service operation.
Social marginal costs are, in all sectors, essentially vehicle
dependent, i.e. they vary with features associated to the vehicle,
namely its characteristics, distances covered, time of day of oper-
ation or the possible presence of other vehicles in the infrastruc-
ture. The amount of passengers or goods inside the vehicles is fairly
irrelevant for the amount of SMCs caused, except to some extent in
the use of stations. For these reasons, the internalization of costs
must primarily be targeted on vehicle operation rather than
passenger or goods size. Such premise implies that, for all transport
sectors, it should be vehicles, not passengers, to be priced for the
use of the infrastructure.
On the other hand, the aim of optimizing social behaviour
behind the principle of social marginal cost pricing should hold that
nal users of the transport service bear the social marginal costs of
their travel decisions. This implies that users of the service should
be priced in accordance to social marginal costs. However, whereas
in the scope of private transport this is straightforwardly done due
to the non-existence of an intermediary service operator, in time-
tabled transport the application of pure passenger short-run social
marginal costs does not make users face the marginal costs of the
vehicle operation because vehicle circulations will occur, in the
short-run, independently of the users decisions.
However, for dynamic efciency of provision and use of trans-
port services, it seems that the more appropriate alternative is to
make the user pay for a due share of the marginal costs caused by
the vehicle operation. A traveller, in choosing between road and
rail, should in principle consider the social cost implied by both
modes, even if the train circulation will happen independently of
the travellers instantaneous decision on the mode to use. It is the
SMC price inclusive of vehicle marginal costs that brings an optimal
demand distribution between the various modes. And it is this
expected optimal demand that should, in the rst place, base the
medium-term decision to have trains circulating as established by
the decision maker (Fig. 1).
But will an optimal service user price (SMC based) occur if it is
the service operator being directly charged for track access
according to SMCP? According to economic theory, in a competitive
market, user prices would be set by the operator equal to the
marginal costs of the service operated. Therefore, if service opera-
tors were charged for track access according to SMC, then the cost
would be perfectly transferred to the nal users. This is presumably
the case of unregulated sectors like roads and aviation, where
transport service providers (buses and airlines) are allowed to
freely set prices to passengers on the basis of the assumption that
markets are competitive. But if the service operator has market
power and is able to determine user prices, the intended effects of
operator SMC charging will be distorted, a case in which there
would have to be regulatory intervention to set user prices equal to
In the railway sector it is likely that in most cases, especially in
the passenger market, the specic features of the railway service e
limited capacity, network coverage, comfort, speed, and the exis-
tence of captives (passengers without personal vehicle, goods of
large size and weight) - cannot be fully replaced by the available
competitors. Therefore, in a large piece of railway undertakings, the
case cannot be made that the market is competitive, and service
user charges should be imposed to reect social marginal costs.
As mentioned, past discussions and research on social marginal
cost pricing in the railway sector have been focused on infra-
structure management. The issue of marginal costs of service
operation in railways is therefore a subject deserving further
research in the scope of SMC pricing. To this aim, two elements
should be covered:
Which types of service operation costs should be regarded as
marginal costs?
Quantication of marginal service operation costs.
The rst itemdeals with an issue already subject to discussion in
the scope of railway infrastructure costs, where it is not always
evident which costs should be considered as variable and which
should be considered xed (see e.g. Rothengatter, 2003). The
framework of analysis must in any case be laid in comarison with
other modes; similar types of costs should have the same treatment
in different modes, for SMCP to provide the right incentives (for
a discussion of policy packaging, se e.g. Verhoef, 2001). This is of
paramount importance in considering marginal rail service oper-
ation costs; as argued, nal user price should include this type of
costs despite the fact that they occur independently of
Fig. 1. Interaction between SMC price and decisions on railway service/infrastructure
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instantaneous nal user decisions, so that demand adjusts ef-
ciently to the alternative transport supply alternatives.
For example, it is not clear whether costs of train acquisition
should be considered as marginal costs in rail, when comparing
with other modes. Whereas they are not included in the travel
decision equation of road users (and consequently they should not
be covered by the rail price), on the contrary they are included in
prices charged to air transport passengers.
We may thus conclude that, unless service operation costs are
included properly in nal users prices throughout all sectors, there
will be a distortion in nal user choices.
4.2.2. Possible funding and charging frameworks per type of activity
To assess possible constraints put by SMCP on private involve-
ment in railway provision, we need to understand the funding and
charging framework associated with the possible activities of
private involvement e infrastructure management and service
According to the principle of economic efciency under the
presence of external costs, it is efcient that the party causing the
external cost compensates the party affected for the caused
Applying this rule in infrastructure management PPPs would
imply that the users of the infrastructure pay the affected parties
for the social marginal costs of their activity in the infrastructure. In
this sense it would be appropriate for the infrastructure user to pay
the external costs of infrastructure to the infrastructure manager
and the external costs e congestion/scarcity, environmental, acci-
dent e to society.
However, in the context of PPPs it would simplify the process of
transference of funds, and perhaps also incentive good practice by
the manager by having it facing commercial demand risks, if the
infrastructure manager were entitled to the payments for external
costs. In this way, the external costs caused by the infrastructure
users would be internalized and the State would be partly or totally
excluded from funding the infrastructure manager, as expressed in
Fig. 2. The approach of funding the infrastructure manager through
track access charges is indeed used by some of the existing infra-
structure PPPs in railways (KuhlI, 2007).
Service operation requires a different approach. Should it be the
service operator paying for social marginal costs to the infrastruc-
ture manager and/or the State, or should those be borne by the nal
users of the transport service?
Like in infrastructure management PPPs, in service operation
PPPs the above stated principle of economic efciency and fairness
under externalities should hold that each party pay the other for
the costs inicted. In this sense the service operator should pay the
infrastructure manager for infrastructure marginal costs caused by
the service, and the State/society for the other social marginal costs.
In addition, as argued above, for the sake of transport user behav-
iour optimization, the nal users of the service should pay the
service operator not only for the short-run marginal costs caused
by themselves (which probably are minimal) but also for the social
marginal costs incurred by the operated service.
Similarly to infrastructure management PPPs, the process of
nancial ows could be simplied if the service operator fully
kept the tariffs paid by the users (instead of directing social
marginal costs to the State) as form of compensation for their
activity (Fig. 3).
4.3. Factors of interference between SMCP and private involvement
The factors of interference between SMC pricing objectives and
the objectives behind the involvement of the private sector in
railways are generally of the same kind as other transport sectors:
Cost coverage: The revenues generated by user charges based
on SMCs may not be sufcient to cover for the necessary
remuneration of the private operator
Risks of revenue: The formation of revenues from SMCP may
introduce high risks of revenue
Incentives: The formation of revenues from SMCP may intro-
duce undesirable incentives on the performance of the private
4.3.1. Cost coverage
The problem of nancing the infrastructure or transport
undertaking is invoked as the core motive behind the late growth in
the use of PPPs in Europe. This seems to be true also in the rail
sector. In conventional PPPs of concession type, the private operator
is entitled to the funds generated by the exploitation of the infra-
structure or service. However, the imposition of a price at the SMC
level may make this solution impracticable, as the generated
revenues may not be sufcient to cover all the costs.
4.3.2. Risks of revenue
The possible introduction of SMCP may have consequences on
nancial risks of transport projects, due to the potential variability
of SMCs. In conventional pricing schemes with xed price, the risk
associated with revenues fromuser charges is directly related to the
uncertainty of future demand. But when marginal cost based
pricing is introduced, two additional risk factors are introduced:
Demand based revenue risk: risk associated with the possible
variation of price with demand, caused in particular by
congestion/scarcity costs;
Future evolution of SMCs: risk associated with the external
uncertainty of evolution of SMCs.
The possible introduction of additional revenue risks will be
translated into an additional risk premium for the operator to be
willing to bear them, which may be unacceptable froma perspective
of value for money for the public sector.
4.3.3. Incentives
The difference in objectives of the public and private parties in
a PPP arrangement puts a challenge on the conciliation of those
Fig. 2. Possible infrastructure management remuneration under an SMCP scheme
(users pay access charges e SMCs e fully to infrastructure manager).
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objectives. The introduction of a price based on social marginal
costs may even aggravate the difculty of this challenge. If the
private operator has powers to inuence social marginal costs and,
in that way, revenues, it will be in its interest to see SMCs at a high
At a theoretical level, one way SMCs may change is through
changes in the congestion/scarcity ratio, affecting the way how the
demand incentive works. In fact, the possibility of increasing reve-
nues through capacity restrictions, by increasing congestion/scar-
city costs, may lead the operator to prefer providing a reduced level
of service, even at the expense of a lower demand.
Besides capacity provision, the operator has an interest in seeing
SMCs at a high level through any other possible means. Therefore, if
its powers allow it in some way to inuence the real or apparent
level of SMCs, it is expectable that it will try to inuence them
upwards. For example, if price has a component proportional to the
accident risk, it will be a protable interest of the operator to see
that risk increase.
4.4. In practise, how may SMCP interfere with private involvement?
Cost coverage, risks and incentives are the main economic
obstacles to the conciliation of SMCP with PPPs. In this topic we
address howthese factors act, in particular, in the scope of railways.
Additionally, we also analyse non-economic factors of potential
relevancy to the issue in the railway sector, namely acceptability
issues and the need for contract renegotiations.
Due to the differences in funding and charging approaches in
the two types of activity where private involvement is possible, we
separately cover service operation and infrastructure management
PPPs. SMCP has direct implication for the private involvement in
railway provision for the purpose of:
e Service operation, if the funding of the service operator is based
on SMCP charges for the use of the service or if it is SMCP
charged for track access.
e Infrastructure management, if the funding of the infrastructure
manager is based on track access charges built on SMCP;
4.4.1. Cost coverage
Cost coverage in the scope of service operation PPPs focuses on
whether the revenues delivered by passenger or goods charges
would be enough to pay for all the costs incurred by the private
operator. Service operation. One of the ENACT case studies analysed
the performance of a service operation PPP (the river Tagus crossing
suburban railway line in Lisbon) (Bernardino, 2009). It has been
estimated that the internalization of the marginal costs typically
considered (IMPACT, 2007) for the use of infrastructure would not
lead to cost coverage of the service operation (as previously
concluded in previous studies, as noted e.g. by Nash and Matthews,
2002). In fact, the SMC price would stay considerably below
currently practised passenger prices (Table 4).
The results showthat revenues fromsocial marginal cost pricing
would rely fundamentally on infrastructure costs (77.7%). Consid-
ering the aggregate revenues of infrastructure, congestion and
noise costs, they represent 94.7% of all SMCP revenues. This result is
a consequence of the well known good performance of railway
transport in the environmental and safety dimensions. It must also
be noted that both air pollution costs and global warming costs
would not be considered in SMC price if they were considered to
already being internalized in other forms of taxation (particularly
a fuel tax or an emissions trading scheme).
However, as we have seen above, the proper reection of
marginal costs on passenger or goods tariffs in the scope of service
operation should include the consideration of operational marginal
costs of service provision, which were not accounted for in the case
study. Their inclusion in the passenger price could change the cost
coverage picture, depending on the types of service operation costs
considered as marginal.
Fig. 3. Service operation concessionaire remuneration under an SMCP scheme (users pay access charges e SMCs e fully to service operator; service operator pays infrastructure
charges to infrastructure manager).
Table 4
Revenues generated by social marginal cost pricing in the Tagus Crossing service.
Cost category Average cost Revenues total (PV)
(/train.km) (*1000) (%)
1. Infrastructure 1,29 48.628 77,0%
2. Congestion/Scarcity 0,20 7.471 11,8%
3. Air Pollution 0,04 1.373 2,2%
4. Global Warming 0,04 1.697 2,7%
5. Noise 0,10 3.691 5,8%
6. Accident 0,01 285 0,5%
Total 1,68 63.145 100,0%
Source: ENACT Case Study B - Tagus River Rail Crossing (Bernardino, 2009).
J. Bernardino et al. / Research in Transportation Economics 30 (2010) 59e73 66
Author's personal copy Infrastructure management. As we have seen above (Section
3.1.1), railway infrastructure provision has very high xed costs
compared to variable costs of its operation, and consequently
marginal costs lie far below its average cost. This implies that
a decit occurs if price is set equal to infrastructure marginal costs.
Furthermore, there are economies of trafc density, which mean
that marginal infrastructure costs decrease as trafc increases.
Although considering external costs from the use of infrastruc-
ture e in particular, congestion, air and noise pollution, and acci-
dents e in the price provides additional revenues, they will still be
far belowcost recovery of infrastructure costs. As we can see in the
price calculation of the ENACT Tagus River Rail Crossing Case Study
(Table 5), external costs add minor additional revenues (about 50%).
Even under much higher congestion/scarcity costs than those
considered, cost recovery in rail infrastructure would still be far
from achievable.
However, it is noteworthy that new railway projects in general
hardly manage to gather enough funds to pay for service operation
costs alone. As a result, any surplus revenues (net of service oper-
ation costs) drawn from current user charges at most are able to
provide a small contribution to cover investment and other xed
infrastructure costs. Whereas, in the road sector, PPPs are used by
some governments with the main purpose of avoiding nancial
burden to the public budget, the same is not generally possible in
railway projects to the extent that revenues are far from enough to
pay for all costs involved. The obvious conclusion is that the situ-
ation on cost recovery of xed infrastructure costs would not suffer
a very signicant relative change by the introduction of SMCP,
comparing to the present state.
4.4.2. Risks
Having the concessionaires remuneration based on SMC pricing
revenues has implications on the risks faced through the amount of
revenues collected. As described above, two main topics arise in
this scope:
Effects of demand risk on revenue risk (demand based risk)
Effects of evolution of SMCs over time on revenues (risk of
evolution of SMCs) Demand based risk. Unlike in conventional demand based
revenue schemes where revenues relate linearly with demand,
this is not necessarily the case when revenues are dependent not
only on demand but also on the tariffs imposed in accordance with
social marginal costs; tariffs based on pure SMCs may, on their
own, depend on demand and circulation conditions in non-linear
ways. Consequently, whereas in conventional demand based
revenues the expectations of revenue risk are equal to the
expectations of demand risk, in SMCP based revenues this may not
be the case.
In service operation, because vehicle demand (in what the
considered railway service is concerned) is in most cases pre-
determined in contract, the effect of vehicle demand variations
over variations of social marginal costs may be neglected as an
issue. In fact, the total amount of social marginal costs that are
caused by the train circulations of the PPP arrangement is in some
extent pre-determined - in what dues to the quantity of demand -
by the decision of vehicle demand in the infrastructure. Such is the
case e.g. of the Tagus river rail concession, where train circulations
for the urban service are pre-determined in contract. Therefore, the
issue of the risk of (vehicle) demand is not relevant in the scope of
centrally determined timetabled transport service franchises.
This apparently would largely simplify the issue of risks of
demand based revenues. However, unlike in infrastructure PPPs, in
service operation PPPs revenues are determined on the basis of
passenger or goods demand, not vehicle demand. It is the fees paid
by the users of the service that will supply revenues. This intro-
duces a different source of risk, analysed in detail in Section 4.5.2.
In infrastructure management PPPs, demand based risk could
theoretically be aggravated by the existence of SMC pricing, if the
infrastructure suffers from congestion and scarcity. However, this
later provision may not be the case in most of the existent or
planned PPPs, which, as we have seen in Section 2, mostly focus on
dedicated lines for specic services that are less likely to face
relevant congestion and scarcity problems, which tend to occur in
more interlinked networks. However, if congestion/scarcity is
relevant in the infrastructure, an additional revenue risk caused by
the pricing scheme would surge.
Due to their lower relevancy compared to other modes, infra-
structure management PPPs in the rail sector have not been studied
in detail in ENACT. However, the applied theoretical propositions on
SMCP revenue risks and incentives are similar for all modes. To
illustrate the possible inuence of the demand/capacity relation on
price, and consequently on risks and incentives, we replicate in
Fig. 3 the conceptual functional form relating price for congestion/
scarcity and the demand/capacity relation, as applied in the ENACT
Simulation Tool for non-road modes.
The reasoning behind the curve is based on the different
components that affect congestion and scarcity costs in scheduled
e For low levels of demand (compared to capacity), there are no
congestion/scarcity costs;
e For higher levels of demand, marginal costs increase as demand
approaches capacity due to the need to adjust schedules to
accommodate all vehicles and to the increased risks of propa-
gation of delays;
e When potential demand
is higher than capacity, in addition to
the costs mentioned in the previous case, opportunity costs
arise fromthe non-satisfaction of part of the potential demand.
The concave form of the relation between demand and price
results in that possible variations in demand (or capacity) translate
into more than linearly proportional variations in price. Conse-
quently, the revenue risk related to demand variations is higher
with SMCP with congestion/scarcity costs included than with
a pricing scheme where price does not depend on demand. Risk of evolution of SMCs. If pure SMC pricing is applied,
revenues depend on the evolution of social marginal costs during
the time horizon of the PPP, which may be uncertain.
The SMC price would, as we have seen, be formed largely by
infrastructure costs, with possibly some importance of conges-
tion/scarcity costs, and little inuence of other external costs. The
Table 5
SMC passenger tariff formation alternatives.
SMC passenger tariff formation alternatives
1. Actual SMC Actual number of Users T

2. Actual SMC Fixed Expected number of users T

3. Expected SMC Actual number of Users T

4. Expected SMC Fixed Expected number of users T

Source: ENACT Case Study B - Tagus River Rail Crossing (Bernardino, 2009).
Potential demand is only satised if it is lower than (maximum) capacity.
Otherwise, an excess demand is not satised.
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contribution to risks of revenue from costs other than infra-
structure or congestion/scarcity can therefore be regarded as
As for infrastructure costs, they may change in relation to the
initial expectations either due to technological modications in
infrastructure or rolling stock, or due to operational efciency of
the infrastructure manager. The rolling stock in the railway sector is
less subject to technological evolution as compared e.g. with the
road sector and therefore future SMCs should be more easily
Congestion/scarcity costs could evolve mainly due to timetable
changes in the network towards a more or less busy network, or
due to technological changes in network operation. In any of the
cases, these may represent a risk of tariff revenues due to their
implications on the SMC price practised.
Such risk may be more or less relevant depending on the PPP
contract extension. The longer it is, the more risk of evolution of
social marginal costs there will be. In the case of service operation
franchises, risks should be small, since contracts last usually for
more limited periods with close to xed technology.
4.4.3. Incentives
The theoretical ways in which SMCP can negatively affect the
incentives faced by the private party were categorized in ENACT in
two groups: incentives to inuence revenues through capacity
provision; incentives to keep SMCs at a high level. It is nowrelevant
to consider how these incentives would function in the railway
sector, both in the scope of service operation and infrastructure
In service operation, like for risks, incentives caused by demand/
capacity relation may likely be neglected in most situations because
the demand is generally pre-determined by contract. Where this
isnt true, i.e. the operator has power to decide on service
frequencies, the allocation of social marginal costs to the nal user
(passengers or goods) could bring an undesirable incentive to the
operator to increase frequencies and with that seeing congestion/
scarcity cost revenues increase.
Railway service operation PPPs have particular kinds of incen-
tives to increase SMCs, not always similar to those incentives found
in infrastructure management PPPs. The types of incentives that
arise in the scope of service operation PPPs are the following:
Demand incentive - The incentive of the operator to increase
passenger demand leads it to putting a higher effort to provide
a service of high quality, including possibly the increase of
service frequency (if that is an option to the operator). This
incentive may or not be affected by SMCP, depending on price
formation rules, as we will see in the following section.
High externality incentive - the private party has an interest in
taking actions to keeping marginal costs at a high level, in case
its powers allow it to do so. In railway services the operator
may e.g. increase the number of carriages to increase infra-
structure costs, underperform on schedule to increase
congestion costs, or underperform on safety actions.
Innovation and cost efciency incentive ein the scope of service
operation PPPs and SMCP, the incentive for innovation and
cost efciency may be affected if improvements in cost ef-
ciency of the operator translate into correspondent losses in
revenues. This may be the case if the SMC price includes
a fraction for service operation costs (not considered in
previous Chapter 4), since the service operator will not have an
interest in decreasing them if they are not translated into
additional prots.
Information asymmetry incentive e an incentive to hide infor-
mation from the regulator on real costs would happen, as
above, if service operation costs took part in the SMC price. In
that case, the service operator would have an interest in
reporting higher costs than the real ones in order to charge
a higher price. Another possible action could be hiding infor-
mation on energy consumption where, like above, the operator
would have an interest to report higher consumption than real.
The three later incentives have in common the interest of the
concessionaire to raise the SMC price. All of themmay be negatively
affected by SMCP. The demand incentive, on the contrary, pushes
the operator to increase revenues through an increase in demand.
The way in which SMCP affects the incentives described is
greatly affected by the rules of price formation, as we will see
In infrastructure management PPPs, the demand/capacity
incentive will only be relevant, likewise for risk, if there is signi-
cant congestion and scarcity, which as mentioned above should not
be the case in most existent or planned rail infrastructure PPPs. Yet,
if that is the case, an undesirable incentive to limit capacity may be
real and should have to be neutralized. As is clear from the obser-
vation of Fig. 4, a decrease of capacity could be of interest to the
private infrastructure operator, since the increase of the demand/
capacity would increase the price faced by railway undertakings.
Like in other transport modes, other undesirable incentives may
occur in the scope of infrastructure operation. The demand incen-
tive will be negatively affected under congestion/scarcity costs,
given that the operator may be willing to lose demand by capacity
restrictions aimed at increasing SMC price. The high externality
incentive could be relevant in the rail infrastructure especially in
the scope of accident costs. The innovation and cost efciency
incentive should be of paramount importance due to the weight of
infrastructure costs in the SMC price, and the power of the infra-
structure operator to inuence those costs through time. If it is paid
according to infrastructure costs, the incentive to minimize costs
and innovate will be null or even negative. The possible information
asymmetry between the infrastructure manager and the regulator
could also lead the biased reporting of costs, particularly by
inating marginal infrastructure costs. Additionally to the incen-
tives referred for service operation, an additional undesirable
incentive may surge in the scope of infrastructure operation:
User discrimination incentive - if the concessionaire has the
ability to choose between users, it will have an incentive to
choose those users with higher marginal costs. The access to
railway infrastructure may be excludable, especially if there is
any scarcity; therefore, the operator may discriminate users
with lower costs to users with higher costs.
Fig. 4. Functional form used in the ENACT Simulation Tool for SMCs of scarcity/
congestion (SMCs/c) as a function of the demand/capacity ratio, for non-road modes.
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4.4.4. Other barriers of non-economic nature
This topic looks briey into other possible barriers, of non-
economic nature, to the conciliation of SMCP with private
involvement in railways. In the railway sector, we highlight the
possible importance of public acceptability and the renegotiation of
contracts. Public acceptability. The transfer of common pricing
schemes to SMC pricing could theoretically bring problems of
public acceptability, either due to the level of pricing or due to the
use of SMCP revenues. However, neither of the issues seems to
potentially bring any signicant problems in the scope of railways.
The new prices will, in principle, be lower than current charging
practises. And the issue of the revenue destination does not seemto
be a major potential constraint for acceptability of SMCP imple-
mentation in railways, since presently user charging revenues
already commonly fully ow to the operators (public or private). Renegotiation of contracts. Usually, concession contracts
between the State and private parties establish that the renego-
tiation of contractual conditions requires the agreement of both
parties. In the case of a possible renegotiation launched by the
State with the aim of introducing SMCP, the predictable rational
behaviour of the private party is the attempt to reap benets out
of the renegotiation. In fact, the circumstance of the private party
having the power to veto the renegotiation intended by the public
party may lead it to strategic behaviour in the pursuit of a better
This kind of practise may be aggravated by the lower objectivity
implied by SMCP in the denition of revenues based on user
pricing. Particularly, the possible introduction of the additional
revenue risks of SMCP could provide the private party with a strong
argument for demanding a generous contract renegotiation for its
However, the problem can be potentially neutralized in two
ways. First, SMC pricing could be established in a non-risky way, i.e.
such that the prices would be predictable and not subject to
conditions of demand or evolution of social marginal costs through
time (e.g. due to technological improvements). As described below
(section 4.5), this seems to be viable in timetabled service opera-
tion, but not in infrastructure management.
The second possibility is to simply substitute any previous
revenues from user charges by correspondingly equal performance
payments proportional to demand. In this case, the public party
would be the one collecting revenues from SMCP user charges. The
only subsisting additional risk faced under this situation would be
the risk of demand introduced by variations in user charges,
a possibility that again may be neutralized if SMC charges are
dened in a predictable way.
Finally, it should be noted that the problem of need for negoti-
ations tends to be less serious in railway service operation than in
infrastructure management PPPs, since contracts have commonly
a smaller term, possibly allowing for its termination before the
introduction of SMCP.
4.5. Possible ways forward to conciliate SMCP with railway PPPs
Possible ways forward to the conciliation of SMCP and railway
PPPs are covered here. We describe solutions for complementary
or alternative funding, analyse the way how alternative possible
price formation schemes can be important in the creation of
inconsistencies between SMCP and private provision, identify
requirements and possible solutions for contractual performance
drivers under different pricing and remuneration regimes, and
nally we address the issue of who should be the party entitled to
collect user charge revenues, from an optimal contractual design
4.5.1. Funding
It was seen that internalization of the marginal costs typically
considered for the use of infrastructure would not lead to cost
coverage of service operation or infrastructure build & operate
PPPs. In fact, the SMC price would stay considerably below
currently practised passenger prices, meaning that decits would
increase with SMCP in relation to the present practise. However,
the proper reection of marginal costs on passenger or goods
tariffs in the scope of service operation should include the
consideration of marginal costs of service operation. Their inclu-
sion in the passenger price could change the cost coverage picture,
depending on the types of service operation costs considered as
Like in other transport sectors, additional funding would
require the use of alternative means of revenue additionally to
SMC user pricing, and the main alternatives available are:
Additional public funding;
Second-best pricing schemes to achieve more revenues.
Additional public funding enables applying rst-best SMCP, but
presses on public decits. Second-best pricing schemes prejudice
allocative efciency in the mobility market and are more complex
to implement. These issues are discussed in previous chapters of
this book and ENACT (2007).
As to what the railway sector is concerned, a few points can be
made: Competition. Second-best pricing schemes get more
complex to implement when there is competition between various
modes. Railway lines are in most cases in direct competition with
other modes, mostly road, but also other railway services, aviation
(for high-speed rail) and even inland waterways. Competition is
most deep in urban areas. Therefore, the application of second-best
pricing in railway lines will generally require complex schemes in
integration with other modes. Decit level. The decit in the railway sector as a whole is
the highest among transport modes. Second-best pricing may
aggravate the picture, as a result of lower prices on nal users. Still,
some service operation PPPs might be nancially viable through
SMCP if marginal costs of service operation are considered.
However, the issue of operational marginal costs of service provi-
sion in railways is a subject deserving further research in the scope
of SMCP. Cross-subsidization. According to Roy (2002) the surpluses
resulting fromthe correction of urban road congestion far outweigh
any decits resulting from the application of marginal cost pricing
elsewhere in the transport system. Therefore, it is possible to
remunerate portions of the transport system in decit, including
railways, through surplus SMCP revenues in urban roads. Such type
of solution would dispense any additional public funding or
increased pricing.
4.5.2. Price formation in service operation Price formation alternatives. The risks and incentives
caused by SMCP in the context of service operation depend largely
on the rules of formation of passenger tariffs.
According to the principle, suggested above, that nal users of
the transport service should face a price that reects the social
marginal costs involved in the railway service, the sumof the tariffs
J. Bernardino et al. / Research in Transportation Economics 30 (2010) 59e73 69
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paid by the users should equal the social marginal costs of the
vehicle operation:
With T
e tariff of user I in vehicle-trip j
e social marginal costs of vehicle-trip j
The application of this rule still allows for different alternatives
of user tariff formation schemes contractually agreed between the
public and private parties of the PPP. Tariff formation alternatives
could differ in two ways:
Tariffs may be alternatively set according to expected or actual
social marginal costs. Setting tariffs in accordance with actual
SMC would consist on the regular updating of tariffs in accor-
dance to the evolution of the level of SMC, which may vary with
time due to changes in technology, ow conditions or other
factors. In alternative, tariffs may be set according to expected
SMC by a xed value, dened at contract agreement and based
on the SMC expected to happen during the contract period.
Tariffs may be alternatively set according to the expected or
actual number of users, withtariff formationsimilar tothe above.
The combinations of the possibilities outlined lead to four
practical alternatives of passenger tariff formation, within a PPP
contract. They are presented in (Table 5). Performance of price formation alternatives. The advantages
and disadvantages of these alternatives on risks and incentives, and
on market efciency, may be analysed.
Focussing on the effects of the passenger tariff alternatives on
risks and behaviour incentives to the party collecting the revenues,
a qualitative analysis is provided and outlined in (Table 6).
In relation to number of passengers, tariffs based on actual
demand (i.e. real time demand) would neutralize bothrevenue risks
and incentives, due to the fact that the tariff adapts permanently to
produce revenues equal to social marginal costs and therefore
revenues are independent of passenger numbers. It is noteworthy to
mention that the neutralization of risks and incentives is of absolute
nature, inthe sensethat besides not producinganyincremental risks
and incentives in relation to conventional demand based revenue
schemes, it actually totally neutralizes them, turning out to be
a similar remuneration scheme to a xed subsidy from the State. In
opposition, a tariff based on the initially expected demand would
produce risks and incentives, namely a risk of revenues dependent
on the demand and an incentive to increase the number of passen-
gers. The later case is, in what directly depends on passenger
demand, no different from those of conventional demand based
revenue schemes. It would require a possible dependence between
passenger demand and social marginal costs to introduce additional
indirect effects of passenger demand over risks and incentives;
however, as noted above, passenger numbers hardlyaffect the social
marginal costs of a scheduled service.
In the case of tariffs being formed on the basis of expected
number of passengers, it can be foreseen that having passenger
tariffs formed on the basis of actual social marginal costs (i.e.
permanently adapting tariffs to the current value of social marginal
costs) would put a risk on revenues and an incentive on the oper-
ator to increase the social marginal costs of its operation, which is
an undesirable outcome. If, instead, the tariff formation scheme is
based on the initially expected SMCs during the whole course of
the scheduled service, then no revenue risks or undesirable
incentives will be caused by possible SMC variations. In this respect,
the renegotiation of the Tagus rail crossing would easily enable
a tariff formation scheme based on expected marginal costs
because it was set for a period of only 6 years, allowing for an
accurate prediction of marginal costs during that time.
Evaluating the available tariff formation alternatives from the
scope of risks and incentives introduced, it can be observed that
alternatives 1 and 2 are dominated by alternatives 3 and 4, i.e. the
later alternatives showa better or at least equal performance in the
two dimensions of analysis. Comparing the winner alternatives, 3
and 4, it can be seen that there is a trade-off between risk bearing
and productive efciency. While alternative 3 has no risks and
incentives whatsoever, alternative 4 introduces a desirable incen-
tive on quality of service at the cost of an additional risk premium
due to revenue uncertainty.
Moreover, analysing the performance of the two winner
alternatives, it is doubtful that the one relying on actual demand
would work well from the practical perspective given the unde-
sirable feedback price/demand inter-relations that may surge. E.g.
a lower than expected level of demand would lead to an increase of
passenger prices, which would again lead to a further decrease in
demand, and so on. This price setting scheme may thus introduce
instability in the price/demand equilibrium which may even
damage the original objectives of SMCP. For this reason, the alter-
native based on expected costs and users (alternative 4) seems to
be the best choice of SMCP tariff setting rules.
Tariff formation rules based on expected costs instead of actual
costs is a deviation frompure SMCP, if costs do not evolve as expected
during the period concerned. Nonetheless, in the case of a PPP in
whichtraincirculations aredeterminedbycontract (as usual), andare
therefore relatively inexible during that period, the costs caused by
train circulations do not depend onthe tariff level (which determines
the number of passengers). What is crucial for an efcient allocation
of resources is that the initial decision on the volume of train circu-
lations takes intoaccount their expectedsocial marginal costs andthe
expected passenger demand with SMC pricing. After the medium-
term decision is taken, it seems to be reasonably irrelevant for
dynamicefciencytopriceusers accordingtotheexpectedSMCs that
based the decision or the SMCs that truly occur. For this reason,
possible market inefciencies caused by deviations from pure SMCP
intheshort term(withxedtraincirculations) shouldnot berelevant.
However, this plausible hypothesis could be a subject of further
The solution of having SMC prices formed on the basis of
expected rather than actual costs seems, for the reasons pointed
above, to be more viable in the railway sector than in the road
sector. On one hand, its timetabled nature removes some
Table 6
Effects of alternative passenger tariff formation rules on risks and incentives.
SMC passenger tariff formation
Effects towards:
Revenue Risks Behaviour
1. Actual SMC Actual Number of Users Caused by:
- evolution of
No incentives
2. Actual SMC Expected Number of
Caused by:
- evolution of
- passenger
- raise SMCs ()
- increase users
3. Expected SMC Actual Number of
No revenue risks No incentives
4. Expected SMC Expected Number of
Caused by:
- passenger
- increase users
Legend: () - desirable incentive ; () - undesirable incentive.
Source: ENACT Case Study B - Tagus River Rail Crossing (Bernardino, 2009).
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undesirable risks and incentives and, on the other hand, there is
greater predictability of technological elements.
4.5.3. Performance incentives
Contractual design is key to achieving a desirable performance
of the private operator. The requirements of performance drivers in
a PPP with SMCP depend on:
1. The revenue structure of the operator (which could or not be
partly based on user tariffs);
2. The rules of formation of price.
If revenues of the operator are based on other sources than
passenger tariffs, the incentives it faces are independent of the
pricing regime. If, on the other hand, the operator owns revenues
from passenger tariffs, the incentive effects of SMCP depend on the
tariff formation rules, as described above. In the later situation,
there may be the need to counterbalance negative incentives
produced by SMCP. This would be the case of incentives whereby
the operator has advantages in contributing to an increase in SMC
price (demand/capacity incentive, high externality incentive,
innovation and cost efciency incentive, information asymmetry
incentive and user discrimination incentive).
Answers for these undesirable incentives are provided in great
extent by types of performance drivers already applied in present
railway service operation contracts. For example, the high exter-
nality incentive can be addressed by penalties related to delays,
passenger safety, maintenance of material goods and adequacy of
the transport capacity to the demand levels. The problem of
information asymmetry is also commonly addressed by penalties
already foreseen in service operation contracts like the one covered
in the ENACT case study. The problem of innovation and cost ef-
ciency incentive can be solved through price setting rules, by
setting price according to initially expected costs instead of actual
costs; as described above (Section 4.5.3), this solution would
eliminate any incentives to raise SMCs. An alternative mechanismis
having a form of benchmark regulation whereby the operator
would be awarded or penalized for its cost efciency compared to
a given benchmark.
Table 7 provides a qualitative account of the different require-
ments for performance drivers, according to pricing scheme, allo-
cation of revenues and price setting rules.
A conventional pricing scheme with tariff revenues owned by
the operator is one with a comparatively low need for performance
drivers because it features a demand incentive which pushes the
operator to provide a high quality service in order to attract
Under an SMCP scheme, the need for performance drivers
depends on the owner of the tariff revenues and varies with the
rules of price setting. If the operator is remunerated through public
funds (and not tariff revenues), the requirement is high compared
to the previous case, because in this situation there is not
a demand incentive. In the situation where the operator is remu-
nerated through tariff revenues, and price is set according to actual
demand, any incentives will be eliminated; this corresponds to an
incentive situation similar to the one where the operator is funded
through public funds. In the case where price is set according to
expected demand and actual SMCs, there will be a demand
incentive but also incentives for the operator to raise SMCs. Due to
the later incentive, this solution should require performance
drivers of magnitude certainly higher than the conventional
pricing scheme standard, and perhaps even higher than the public
funds solution. An alternative solution with price based on
expected SMCs would maintain the demand incentive and elimi-
nate the SMC incentive, which puts it in a similar situation to
a conventional pricing scheme, where the need for performance
drivers and monitoring is minimized in comparison with the other
In summary, the level of needs for performance incentives and
monitoring would be higher or equal than that under a conven-
tional pricing scheme, depending on the revenue structure of the
operator and, in case it is based on user tariffs, on the rules of price
setting. An SMCP based remuneration solution potentially offers
less need for contractual performance drivers, since it may be able
to include a natural demand incentive.
4.5.4. Who should be the owner of user charge revenues?
Perhaps the biggest choice to make for PPP contractual design is
to dene how the private party is remunerated. In the traditional
concession model of PPPs, the State gives the private party the right
to exploit the infrastructure or service, collecting the revenues
generated by it. But, when prices are set on the basis of marginal
costs, the possible added risks and incentives are an additional
major issue to consider under this contractual choice problem.
In fact, the issues that arise concerning the willingness of
a private party to enter a PPP agreement and to provide socially
desirable deeds by the existence of SMC pricing, are only relevant if
the private party is remunerated through user charge revenues.
Like above, the type of analysis changes with the type of railway
activity with private provision, i.e. on whether we are talking about
service operation or infrastructure management. Service operation. The analysis of the factors for an
appropriate retention of SMCP revenues in timetabled railway
service operation suggests that it would be feasible and, possibly,
the best option, to maintain the status quo of concession type
partnerships and keep handing user charge revenues to the private
Table 7
Level of need for contractual performance drivers and monitoring, depending on the pricing scheme.
SMC Pricing
Conventional pricing scheme
(actual PPP)
private partys revenues based on SMCP public funds
price setting based on .demand
actual expected
price setting based on .SMCs
actual expected
Incentives Demand () Demand ()
Raise SMC ()
Demand ()
Requirements for performance drivers and monitoring /
Legend: () - desirable incentive ; () - undesirable incentive.
Source: Adapted from ENACT Case Study B e Tagus River Rail Crossing (Bernardino, 2009).
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An appropriate tariff setting scheme theoretically can simulta-
neously t the SMCP principle for railway passengers and maintain
the advantages of a conventional pricing scheme, which provide an
incentive for good performance through attraction of endogenous
demand - avoiding additional needs for contractual performance
drivers. This conclusion departs from the assumption that nal
users should be the ultimate bearers of the marginal costs caused
by the operation of a train, even though marginal costs are rela-
tively independent of the number of passengers. Another
assumption is that vehicle demand (train circulations) on the
infrastructure is determined in the beginning of the contract, and
that therefore congestion/scarcity costs of the train service would
be set a priori and not subject to changes during the contract
timeframe. The alternative price formation rules allowed by the
above principle have, as we have seen, different implications on the
revenue risk and incentive framework; the analysis of the effects of
the available price setting rule alternatives on risks, incentives and
also price/demand stability, resulted in that the alternative of
having the price formed on the basis of expected SMCs and number
of users would be the best. Such price setting alternative maintains
the risk and incentive framework of a conventional pricing scheme,
while guaranteeing dynamic stability of price and demand.
Although such a tariff setting solution does not continuously follow
the evolution of SMCs, it has still been considered an acceptable
marginal cost based price setting from the perspective of mobility
market efciency, since SMCs are determined a priori through
centralized decision-making. The tariff setting scheme suggested
would thus allow maintaining the status quo of toll based funding
practises without affecting risks and incentives. Finally, the possi-
bility of keeping current funding solutions in the railway sector
based on user charging revenue should not carry signicant addi-
tional non-economic barriers, such as public acceptability.
However, public funding is also an option to consider. It may
even be the most appropriate, depending on the degree of exi-
bility needed for price changes during the private granting time-
frame. The possible need to allow price exibility during the
timeframe of the contract, in order to adapt the price to any
changing circumstances, may justify the use of public funding.
There are three ways why this need may arise:
1. There may be changes in the pricing framework of the trans-
port system during the contract, with the need to adapt
(second-best) pricing to implementation of marginal cost
based pricing in other pieces of infrastructure;
2. Demand of train circulations may not be entirely determined
a priori, with the service operator or the infrastructure
manager having the possibility of making changes during
contract timeframe, and;
3. There may be changes in technological elements of infra-
structure or rolling stock during the contract timeframe that
justify the change of prices.
In either case, the traditional concession model may be aban-
doned to a private remuneration scheme not directly related to user
charge revenues. Infrastructure management. In infrastructure management,
the need for price exibility is imperative. Contracts for infrastruc-
ture provisions last for thelongterm, wheredemand, technologyand
transport network-price development are not predictable. The risks
andincentives that thus takeplaceareof similar veintothoseof other
transport infrastructures.
ENACT (2009) argued that a public funding based private
remuneration scheme would be generally most appropriate in the
road sector, whereas in airports, on the contrary, a user charge
remuneration scheme was regarded as a possibly preferable solu-
tion. In the road sector, revenue risks and undesirable incentives
were estimated high due to various factors, and their elimination is
feasible by removing user charge revenues from the private fund-
ing. Moreover, the public funding solution is already widely applied
in motorways around Europe. On the contrary, in airports the
removal of user charges from the infrastructure operators remu-
neration scheme was deemed difcult due to institutional accept-
ability issues (see also the Chapter on airports in this special issue).
In commercial aviation, a self-nance paradigm is dominant, and
changing it would likely face political and institutional barriers. On
the other hand, current pricing schemes in airports usually already
take into account scarcity costs, and therefore the introduction of
pure SMCP would not produce totally new effects.
Railway infrastructure management seems to be closer to the
case of roads than airports. There is nothing like a nancial self-
sustainability paradigm in railways. Although pricing might take
account of scarcity costs in some railway networks in a few Euro-
pean countries, a consistent market for railway service provision is
not yet established in the majority of cases. A pricing system based
on SMCP featuring highly variable scarcity costs is yet a relatively
new thing, and the use of PPPs is still immature. Moreover, a large
part of the railway infrastructure PPPs in development already
relies on a private remuneration scheme based on performance
payments rather than user charging (KuhlI, 2007), which suggests
that some regulators are already considering such a remuneration
solution as the most appropriate one, evenwithout the existence of
pure SMC pricing. For all these reasons, it seems that the public
funding solution should be, in most cases, the best solution for
private remuneration.
5. Conclusions
Private involvement in the provision of railway services has
been increasing in Europe, and is today extensive in service oper-
ation and giving apparently growing steps in the scope of infra-
structure management (although focused on specic services or
needs). Like in other transport modes, difculties in conciliating
social marginal cost pricing with the use of publiceprivate part-
nerships in the rail sector may arise.
Past discussions and research on SMCP in the railway sector
have been focused on infrastructure management. We have argued
that, to appropriately pursue the objective of allocative efciency of
social marginal cost pricing, the discussion should be extended to
service operation. Final user (passengers or goods) pricing should
include not only the marginal costs commonly considered for
infrastructure use but also those marginal costs directly related to
train operation, such that prices are comparable with other modes.
Exactly which service operation costs should be considered as
marginal is something in need of further research.
Concerning cost recovery in the scope of infrastructure
management, present day revenues from user charging are in
general not enough to cover any signicant part of the xed costs
involved in the investment on construction and management of
new rail links. As such, a possible introduction of social marginal
cost pricing should not cause a major change in the current situa-
tion, in relative terms.
In the scope of service operation the implications are different,
since rail service operator revenues presently extensively cover its
costs. It is clear that a nal user (passenger or goods) price based
solely on infrastructure costs and the remaining external costs
would be rather lower than present tariffs. Yet, as mentioned above,
operational marginal costs related to the rail service provision
should also be included in the nal user price, and their nature and
amount is still unclear.
J. Bernardino et al. / Research in Transportation Economics 30 (2010) 59e73 72
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Undesirable risks and incentives to the private party are caused
by social marginal cost pricing, if its revenues rely on user charges.
The problems introduced seem to be more important in the scope
of infrastructure management than in service operation, mainly
due to a difference in their typical contractual timeframes of
operation and consequent on the rigidity of prices during the
In service operation, the analysis of the factors for an appro-
priate owner of SMCP revenues in timetabled railway service
operation suggests that it would be feasible, and possibly the best
option, to maintain the status quo of concession type partnerships
and keeping handing user charge revenues to the private party. An
appropriate tariff setting scheme theoretically can simultaneously
t the SMCP principle for railway passengers and maintain the
advantages of a conventional pricing scheme, which provides an
incentive for good performance through attraction of endogenous
demand. However, a public funding solution may alternatively be
the appropriate option if, for any of a set of identied reasons, price
exibility is required during the contract timeframe.
In infrastructure management, the need for price exibility is
imperative. Contracts for infrastructure provision last for the long
term, where demand, technology and transport network-price
developments are not predictable. The risks and incentives that
thus take place are of similar vein to those of other transport
infrastructures. Moreover, unlike the airport sector, the railway
sector does not face any kind of institutionalized self-nancing
paradigm. Therefore, it is recommendable that the private infra-
structure manager is compensated through means other than user
charge revenues.
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