JOURNAL OF ADVANCED TRANSPORTATION

J. Adv. Transp. 2011; 45:107–116

Published online 11 June 2010 in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/atr.116

Effects of regulation changes in seoul bus system: private bus

operation under non-competitive fixed price contract

Songju Kim1* and Euiyoung Shon2

1
Center for Transportation & Logitics Research, Korea Aerospace University, Goyang, South Korea
2
Department of Transportation Engineering, University of Seoul, Seoul, South Korea

SUMMARY
One of crucial measures introduced under Seoul Public Transport Reforms 2004 was the regulatory framework
change of intra-urban bus from the poorly regulated private operations with operating subsidy, towards the
highly regulated one via fixed price contracts. The focus of this paper is placed on (1) addressing the challenges
newly faced after Seoul Bus Reform 2004, and (2) proposing some strategies in order to ensure better bus
operation overall the reforms was a success in many aspects, resulting in the increase of patronage of urban
transit, the dramatic drop of bus accidents, and introducing exclusive median lanes. Unfortunately, the
previously small, family-owned, inefficient bus companies were transferred to monopoly franchises under the
reforms, thus institutionalizing a non-competitive supply situation. The exclusive operating right-of-way is still
protected as a judicial precedent set by the Korean Supreme Court. The current non-competitive bus contracts
such as a sole-source negotiation procurement must be modified into competitive tendering in the long run, and
the major obstacles to this strategy and the detailed scheme are reviewed. Further, the short-term strategies was
proposed including (a) the development of more sophisticated standard cost model incorporating a route
structure and/or the patronage change; (b) the introduction of yardstick regulation; and (c) extended incentives
and penalties. Copyright # 2010 John Wiley & Sons, Ltd.

KEY WORDS: Seoul Bus System; Reform; Yardstick Regulation; Privatization

1. INTRODUCTION

On July 1, 2004 the Seoul Metropolitan Government (SMG) introduced major public transportation
reform measures in the city, including the demarcation of ‘‘median bus lanes’’ on key corridors, the
introduction of a ‘‘semi-public’’ bus management system, bus network restructure, and a fare and
ticketing system integration across modes. One of crucial measure introduced in the reforms was the
change in regulatory framework of intra-urban bus. Prior to the Seoul Public Transport Reforms 2004,
bus companies were privately owned and operated with subsidy but poorly regulated. The fares were
set by the municipal authority, the SMG since 1994, but network wise, the public played no role in
route management. Under this reform, private companies are still operating but under fixed-price
contracts. Also the revenue became to be managed by the SMG and the route structure, the level of
service, the quality of service has been highly regulated.
In this paper, we investigate (1) why Seoul aimed for the strong regulation while other countries and
cities move towards deregulation and privatization of urban transit; (2) what are the effects and the
challenges under the new regulatory scheme; and (3) some strategies to implement to solve new challenges.

2. THE CAUSES AND EFFECTS OF SEOUL BUS REFORM

Reform of how bus services are supplied has been occurring in many countries. Theses significant
changes in the recent periods focus on two aspects; one is the more cost efficient delivery of services

*Correspondence to: Songju Kim, Research Fellow, Center for Transportation & Logitics Research, Korea Aerospace
University, South Korea. E-mail: [email protected]

Copyright # 2010 John Wiley & Sons, Ltd.

108 S. KIM AND E. SHON

and the other is to attract more patronage. Similarly the patronages of Seoul transit, both buses and
subways had been decreased since the mid 1990s, although they still carried more than 50% of all trips
in the Seoul Metropolitan Area.
Prior to the reform, Seoul buses were provided by private enterprise under de facto franchises
granted by the SMG since the exclusive right-of-way of a pre-existing operator is still protected as a
judicial precedent (but not biding one) set by the Korean Supreme Court. Since 10 years prior to the
reforms, the Ministry of Construction and Transportation (currently ministry of land, transportation,
and maritime affairs) entrusted the right of controlling fares to the municipal government of Seoul. In
other words, the Seoul buses was weakly regulated, and had characteristics of bus industry in
developing countries, such as heavily competitive on profitable route, poor service, high accident rates,
etc. The motivations of the Reforms 2004 include:
(1) Bus routes according to private companies’ interest: cross-subsidy between profitable routes and
unprofitable ones;
(2) declines of patronage and poorly regulated;
(3) poor service—unpunctuality and reckless drivers;
(4) unstable employment and volatile labor relation;
(5) deteriorated bus companies; and
(6) no competition within market as well as no competition towards market because of exclusive
operating right-of-way.

Firstly, the fare integration between bus and subways was the most noticeable change to transit users
under Reforms 2004. A new fare structure is an accumulated distance-based fare system with a free
transfer across mode. Prior to the reforms, subways already had fare integration and an independent
distance fare system across most of subway operators, but not with buses. On the other hand, Seoul
buses had a flat fare and no fare integration with other buses or with subway.
Secondly, the responsibility of the route management transferred to the municipal government. The
SMG reorganized buses with more demand responsiveness, changed the numbering systems to
accommodate the original and destination zones, and most importantly designated four colors to
distinguish different types of buses. Blue buses are major arterial (urban trunk) lines, green is for feeder
lines, yellow for circular lines and red for suburban express.
Third, there was the critical difference in the mechanism of revenue collection and transfer. Under
the reforms, private bus companies are still operated but keep none of the revenue. Their operating
costs are reimbursed by the authority which also pays a management fee. This is done under the fixed-
price contracts mechanism—similar to franchise operators in the East Coast in the United States. After
collection mainly done by smart card transfer, revenue are prorated and transferred into private
companies based on vehicle-km supplied, regardless of boardings. The prorated amount is calculated
by the standard cost model based on the mostly actual spending of each company with some caps and
the optimal number of drivers to operate one vehicle set by the local governments.
Other measures under Seoul Pubic Transport Reforms 2004 include the pilot program of tendering
in four major route—but still non-competitive, the demarcation of exclusive median bus lanes in seven
key corridors, only CNG buses to operate in Seoul in 2010, the bus management ITS technology and so
on. In many countries, governments are pushing for the introduction of competition in the organization
of public services and more broadly in public procurement. In order to foster competition, competitive
tendering, privatization and deregulation in public transit became more common.
Seoul Public Transport Reforms 2004 was a success in many aspects such as the increase of
patronage of urban transit, the dramatic drop of bus accidents, the slowing down the modal share of
private cars, introducing exclusive median lanes, the increase of vehicle speeds, and so on. One
successful aspect of the Reforms 2004 is the increase of transit patronage. The number of the total
transit users increased by 11.2% from 2004 to 2007. Among them, the number of bus patronage
increased by 21.2% in the same periods.
The most dramatic success of Seoul Public Transport Reforms 2004 is the decrease of bus related
accidents. The number of accidents happened in the first half of 2007 dropped by 43.1% than the same
time in 2004. Further, the fatality rate is down by 55.8% between the same periods.

Copyright # 2010 John Wiley & Sons, Ltd. J. Adv. Transp. 2011; 45:107–116
DOI: 10.1002/atr
 EFFECTS OF REGULATION CHANGES IN SEOUL BUS SYSTEM 109

Another successful aspect of the Reforms 2004 was exclusive median bus lanes. Currently, Seoul
has 84 km of exclusive median bus lanes at seven key corridors, and the curbside bus lanes reached
293.6 km. In the case of median bus lanes, its travel time variation is five times less than other bus lanes.
Also a vehicle speed increases for buses by 4 km/hour on average from 2004 to 2005. Also the speed of
private cars is slightly increased (Tables I–II).

Table I. Change in transit patronage and bus accidents in seoul.

Before After reforms Difference
reforms Between the
first half of
2004 and 2008
2004 2004 2005 20005 2006 2006 2007 2007 2008 2008 Differ %
1/2 2/2 1/2 2/2 1/2 2/2 1/2 2/2 1/2 2/2 Change
Changes in transit patronage (1000 person per day)
Bus 4,748 5,170 5,404 5,716 5,709 5,773 5,754 5,561 5,561 5,731 983 20.7%
Subway 4,590 4,539 4,556 4,516 4,635 4,462 4,626 4,457 4,594 4,561 29 0.6%
Accidents (per month)
No. of 663 520 466 470 407 390 377 384 320 351 312 47.1%
accidents
No. of 5.2 2.8 4 4 2.5 2.3 2.3 2.5 3.0 2.5 2.7 51.9%
fatality
No. of 984 767 683 680 610 579 568 588 477 529 455 46.2%
wounded

Table II. Changes in vehicle speed by the types of lanes.

1990 1995 2000 2001 2002 2003 2004 2005 2006 2007
Private cars 24.2 21.7 22.9 21.7 22.5 22.4 22.4 22.9 22.9 23.3
Buses 18.8 18.8 19 19.1 18.9 17.2 18.1 17.6 17.9 19.6
General lane 17.8 18.9 16.7 17.7 17 17.3 18.4
Bus lane (curbside) 21.6 19 18.1 18.9 18.4 18.7 18.4
Median bus lane 22 21.3 21.1 22.3
Edited from Seoul Metropolitan Government [15], Kim [2].

Table III. Regulatory reform major effects on seoul buses.

2003 2004 2005 2006 2007 2008
No. of companies 57 69 69 68 68
No. of routes 365 474 437 395 408 413
No. of vehicles 7967 8266 8294 7766 7748 7736
Operating vehicle percentage (%) 91.8 91.1 89.3 96.2 66.4 92.7
Annual bus subsidy (billion Korean won) 97.2 172.8 227.7 207 163.6 189.4
Daily bus patronage (1000 person per day) 9,918 11,120 11,482 11,315 11,292
Daily operating revenue 5,996 5,996 6,485 6,914 7,022
(million won per day)
Total daily operating kilometer (1000 km) 2,119 2,026 2,003 1,689
Daily operating km/vehicle 288 268 279 226
No. of vehicle per route 20 15.9 15.9 17.4 12.6 17.4
Daily operating revenue per vehicle 335 400 430
(1000won)
Daily operating cost per vehicle 407 503 541
Cost (km) 303.8
Source: Seoul Metropolitan Government [15], Seoul Metropolitan Government 2008, 2009.

Copyright # 2010 John Wiley & Sons, Ltd. J. Adv. Transp. 2011; 45:107–116
DOI: 10.1002/atr
110 S. KIM AND E. SHON

3. EVOLVING PROBLEMS AND NEW CHALLENGES

Seoul Public Transport Reforms 2004 was a success in many aspects such as the increase of patronage
of urban transit, the dramatic drop of bus accidents, introducing exclusive median lanes, and so on.
However, some new challenges are aroused such excessive capacities, the increase of operating
subsidy, minor increase of productivity, changes in the nature of labor relationship.
First, restructuring routes showed only minor success and the municipal authority have struggled to
control the excessive capacities over the last 3 or 4 years. Because the previously small, family-owned,
inefficient bus companies were transferred to monopoly franchises under the reforms, thus
institutionalizing a non-competitive supply situation. This challenge is particularly alarming since the
government take-over led to the over-capitalization of transit firm has observed in the United States,
and many other developed counties. The over-capitalization of transit firms due to capital subsidies can
be explained by the model developed by Averch and Johnson [1] to illustrate that public regulation
creates an incentive for the firm to over-invest in tangible assets.1
Second, there are still no competition in the market and continuous increase of subsidy. The source
of these challenges is still the lack of competition. In spite of lower barrier to enter the market, there
was no competition in the market as well as no competition towards the market. The exclusive right-of-
way of bus operators is still protected as a judicial precedent set by the Korean Supreme Court,
aggravated not only the market failure, but also the network unbalance and the excessive capacities.
The current bus contracts such as a sole-source negotiation procurement is another source of non-
competitiveness. Since there is no competitor, it is automatically renewed. The revenue and subsidy are
apportioned to each operator based on the vehicle-km supplied using a simple linear standard-cost
model. Operators keep none of the revenue but their operating costs are reimbursed with a management
fee. There is no revenue risk for operators that receive a fixed income from governments. This type of
contract is similar to a gross cost regime of a tendering contract with there is significant difference that
the Seoul’s scheme is not exposed to competition. Most counties originally bargained annually and
individually with each company over both costs and transfers. What is different to the practices in
Korea is that the municipal governments bargain with the association of private bus companies in the
region. As a consequence as well as the high mode share of buses in general, private bus companies in
Korea tends to have more strong bargaining power.
Moreover, the transfer based on vehicle-km supplied and no incentive for the increase of patronage
caused a tendency to avoid congested area. It is also adverse to market growth since extra passengers
reduce end-to-end speeds and thus increase costs. Therefore, it is need to create the incentive for
increase patronage and/or for operating congested routes.
Another challenge under the new reforms is only minor increase of productivity even if the huge
success in low accident rates, the increasing number of patronage per kilometer, and the introduction of
median bus lanes. According to the first comprehensive study on the effect of Seoul Public Transport
Reforms 2004 done by the Seoul Development Institute [2], the productivity of Seoul Bus System has
increased by 0.2% between 2003 and 2004. This early study on the reforms used the total factor
productivity (TFP) methods and concluded that 41 companies out of 54 companies showed the
productivity increase.
Oh and Kim [3] estimated the productivity changes of Seoul Bus System by the Public
Transportation Reforms in 2004 examining 52 Seoul bus companies from 2003 to 2005 using data
envelopment analysis (DEA) incorporated undesired output. They found that the productivity has
increased by 3.46% overall and 30 companies out of 52 companies showed the productivity increase
after the Public Transportation Reforms. They concluded that the two policy measures of Public
Transportation Reforms 2004 might explain this productivity increase using the simple OLS model;
one is the increase of passenger per kilometer due to a new distance-based fare system with free
transfers, and the other is the slight increase of the bus speed increase by the introduction of median bus

1
The Averch-Johnson effect is the tendency of companies to engage in excessive amounts of capital accumulation in order to
expand the volume of their profits [1]. If companies profits to capital ratio is regulated at a certain percentage then there is a
strong incentive for companies to over-invest in order to increase profits overall. This goes against any optimal efficiency point
for capital that the company may have calculated as higher profit is almost always desired over and above efficiency.

Copyright # 2010 John Wiley & Sons, Ltd. J. Adv. Transp. 2011; 45:107–116
DOI: 10.1002/atr
 EFFECTS OF REGULATION CHANGES IN SEOUL BUS SYSTEM 111

lanes. However, the route restructures of the Reforms 2004 did not seem to have a significant effect on
the productivity increase in Seoul bus industry since the reduction in number of routes is minor so far
due to reluctance of bus companies.
On the issue of the impact of ownership type on transit productivity, the literature seems to provide
inconclusive results. On the one hand, the direct comparison of public transit systems with private one
shows the former was much less cost-efficient than the latter [4–6]. On the other hand, when
considering the fact that there are various forms of public ownership and that under certain
arrangements privately owned firms operate as if they were public monopolies, the effect of ownership
on efficiency become equivocal [16,17]. Berechman [7] concluded that it is not the type of ownership
per se, which is the determining factor but rather the size of the transit system as well as the degree of
market competition which it faces. Therefore, the little success of route restructures, represented by the
number of routes, the excessive capacities and the lack of market competition might explain only minor
increase of productivity, compared with other performance measures such as low accident rates, the
increasing number of patronage per kilometer, etc.
The last, but least challenging problem for the SMG is that the regulatory reforms caused the change
in the nature of labor relationship in bus industry. After the reforms, the number of required personnel
to operate a vehicle and the wage cap are determined by the standard cost model and the local
government has the authority of setting the costs and reimbursing them. Naturally, bus union does not
want to negotiate with management with little power, and talk directly to the municipal operator who
has the real power.

4. INTRODUCING COMPETITION

To introduce the competition, the proposed strategies proceeded in two directions: (a) expanding
competitive tendering as a long-term solution, and (b) developing short-term solutions that modify the
current regulatory schemes as well as accumulate the information for tendering in the future. With a
gradual increase of tendering, the short-term strategies were proposed to introduce more competition
including (a) developing more sophisticated standard cost model incorporating a route structure and/or
the patronage change; (b) introducing a yardstick regulation; and (c) extended incentives and penalties.

4.1. Standard cost models

To develop a sophisticated standard cost model for bus competitive tendering, the SMG started to
incorporate a route structure and/or the patronage change as well as more than one type of payment for
tendering contracts. In the case of Norwegian bus transport, some counties started adopting a standard-
cost model to determine annual transfers, and the county and the companies agreed upon a set of
criteria for calculating costs of operating a bus-network in the late 1980s. It is a linear model that links
driver costs, fuel costs, and maintenance costs to the number of bus kilometers produced for different
categories of routes (from inner-city, low speed to long distance, high speed routes). Given fares and
route schedules, the standard-cost model determines the level of transfers that is granted by the
regulator.
Although the SMG has the similar linear standard-cost model, there are significant differences. In
the Seoul scheme, the transfer amount is calculated by realized costs of each company, not by
anticipatory costs set by the benchmark in the same year, not for next year (Table IV).

4.2. Yardstick regulation

The second option of short-term solutions is yardstick regulation by benchmarking the standard cost of
bus companies in good performance. Yardstick competition, proposed by Shleifer [8] is to regulate
local monopolies producing a homogeneous good in terms of price. The main characteristic of
yardstick competition is that transfers are based on a benchmark estimated on the basis of cost
performance of a larger set of companies Shleifer [8]. Rate-of-return or cost-of-service regulation
typically allows firms to set prices that cover all costs, but no incentives for efficient production are
provided. In recent years, price-cap regulation, which gives firms better incentives for efficient

Copyright # 2010 John Wiley & Sons, Ltd. J. Adv. Transp. 2011; 45:107–116
DOI: 10.1002/atr
112 S. KIM AND E. SHON

Table IV. Basis of contractor payment in us bus contracting.

Payment basis Sole factor Partial factor
in payment in payment
Cost plus fixed fee 55 11
Fixed fee 9 23
Hours supplied 85 45
Miles supplied 20 25
Passenger boardings 25 4
Others 8 9
Source: Transportation Research Board [12], Contracting for bus and demand-responsive transit services: A survey of U.S.
practice and experience.

production, has been used to regulate natural monopolies Laffont and Tirole [9]. The regulator sets a
price cap that will not be changed for a regulatory period, usually several years.
One example of bus transit contracts using yardstick regulation is Norwegian bus transport. The
important aspect of the Norwegian scheme is that the same standard cost model applies to all
companies within a county; hence, the some form of yardstick regulation. This makes the regulatory
scheme in Norway higher powered: Once the criteria are set, realized costs by one company that
happens to deviate from the standard-cost figures, will not affect the level of its next annual lump sum
transfer (Table V).
However, there is an expected problem with price-cap/yardstick regulation to introduce in Seoul bus
industry. There is the possibility of a typical situation of deadweight loss, due to setting the too high-
price cap. Under the current Seoul bus system, almost all contracts are negotiated through collective
bargaining between city governments and the representatives of Seoul bus association. Additionally,
standard cost contracts did not show an appreciable effect on cost compared to the individually
negotiated contract separately in Norway, although the standard cost contracts have elements of
yardstick regulation [10].

4.3. Management objectives and incentives/penalties

The performance standards are generally enforcing through the use of incentive and/or penalty
provisions. These incentive and penalty provisions can be grouped into four types based on how the
potential for profit is intended to be affected Halvosen [11]. The first type is the most commonly used
method, direct increase or reduction in revenue. The second type is reputation, which affect the future
contracts or contracts elsewhere in the world. The third type of incentive or penalty relates the length of
the contract. The final type is the provision that are designed to affect individual employees of the
contractor, for example, the agency have a right to bar specific employees from working on certain
activities.
Many public authorities specify financial penalties for unsatisfactory performance in addition to the
ultimate penalty, cancellation of the contract. Judiciously administered, financial penalties can enhance
the likelihood that contracted service maintains high standards of quality and performance. In the cases

Table V. Number of Norwegian counties using each type of bus transit contract.

Types of contract 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Individual 16 13 12 11 11 9 8 7 2 1 0
negotiation
Standard cost 4 6 7 8 8 9 9 9 10 7 3
with yardstick
Subsidy capa 0 0 0 0 0 1 2 3 7 11 16
Source: Dalen and Gomez Lobo [10].
a
In the early to mid-1990s, the search finding the regulatory scheme of bus transport further, Norway adopted the new type of
contract, a subsidy cap, which has replaced the former two contracts. The companies and the county agree upon a reduction in the
level of governmental transfers by X% per year, over a 5 years period. This last contract was introduced as a compromise after
counties threatened to tender network services [10].

Copyright # 2010 John Wiley & Sons, Ltd. J. Adv. Transp. 2011; 45:107–116
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 EFFECTS OF REGULATION CHANGES IN SEOUL BUS SYSTEM 113

of the US bus transit, incentives generally have not been used in competitively tendered bus services
because public authorities have assumed that the profit motive will be incentive enough for a
responsible private provider. Only one quarter of the reported contracts offer monetary rewards while
to discourage poor performance, 44% include monetary penalties and 46% include related provisions
for liquidated damages (Table VI) [12].
Incentives must be explicitly defined by using the simple and clear management by objectives
(MBO), and lay out binding legal obligation for payment. The measurable performance criteria
generally include on-schedule performance, percentage of missed trips, percentage of increased
patronage, road-call frequency, and so on. The compensation amount must be based on the degree of
achievement of such criteria. One simple example is the quality incentive contract of London buses.
Based on the degree of on-schedule performance, the incentive or penalty amount is decided, ranged
from the maximum 15% of contracted cost as incentive to 10% as penalty for poor performance.

The currently incentive of Seoul buses is minimal, less than 2% of the contract cost; thus lump-sum
incentives should be desired. For example, to give out 50% of the cost reduction or revenue increase
amounts to the responsible company. Also it is easily combined with the MBO, for example, if a cost
reduction of over 3% in 4 years is the MBO, then it might further be agreed that ‘‘the half of the first
year’s saving will be an earned incentive to be distrusted to all employees and the 25% of the second
year’s saving will be for the first two level of management. . ..’’ Lastly, the excessive high penalties or
penalties based upon unreasonable standards should be avoided, since they impose additional costs on
both the public authority and the contractor.

4.4. Prerequisite for tendering

The first and prime prerequisite for expanding tendering is to pass the legislation or (and) policy to
foster or permit tendering. There are various tiers of laws and policies that might allow it. The first
option of passing legislation to permit tendering in Seoul is by adding amendment(s) to Existing
National Passenger Transport Act. It is the most critical, domineering, and highest tier of transportation
law governing both intra- and inter-urban passenger transport. Although the current National Passenger
Transport Act does not explicitly prohibit tendering, the exclusive operating right-of-way is still
protected as a judicial precedent set by the Korean Supreme Court. By adding amendment of
abolishing or expiring the current exclusive operating right-of-way of route will foster tendering.
Tendering let the labor relation return to the bargaining between labor and bus companies.
The second option is passing the nation policy to foster tendering such as the Urban Mass
Transportation Act of 1984 in the United States. Under this law, federal government encourage public
transit to explore the option of tendering since it is required to give non-discretionary funds only to
public operators that show their consideration and its proof of contracting.
The third one is of having a prerequisite legislation for tendering by creating an executive power of
local government. The example of this case is the Greater London Authority Act 1999. The law grants
strong executive power to London Mayor and City Council for adopting the regulated tendering as
opposed to the complete deregulation of buses outside London.
Another required law to expand tendering is the legislation for guarantee employment succession
when the winner of a tender changes.

Table VI. Number of US bus contracts with performance incentives and penalties.
Performance provisions Number of bus contracts Percentage of bus contracts
Liquidated damage 45 45.9
Penalties 43 43.9
Incentives 25 25.5
Total reported 98
Edited from Transportation Research Board [12], Contracting for Bus and demand-responsive transit services: a survey of u.s.
practice and experience.

Copyright # 2010 John Wiley & Sons, Ltd. J. Adv. Transp. 2011; 45:107–116
DOI: 10.1002/atr
114 S. KIM AND E. SHON

A number of obstacles impede to expand competitive tendering of Seoul buses: include legal
barriers and political oppositions. The current judicial precedent of an exclusive operating right-of-way
and the oppositions of both the association of private bus companies and organized labor are the clear
examples of legal and political barriers. The labor opposition against tendering will continue until basic
retirement benefit is guaranteed by law as well as the working condition must be secured and monitored
continuously.
One of the reason that tendering must expand quickly is that the strong bus union in Seoul hope for
the government’s takeover the ownership and operation of bus companies. The two public corporations
operating Seoul subway system—Seoul Metro and Seoul Metropolitan Rapid Transit Corporation—
pay their train operators more than the bus drivers by 30% as wages. Further, the job security and
compensation packages are higher. The employees of Seoul subway enjoyed the labor-protective
provisions, such as Section 13(c) of the federal Urban Mass Transportation Act—the labor protection
clause mandating that no recipient of federal money can ‘‘worsen the position of a transit employee.’’

4.5. Tendering scheme

Under the gross cost contracts, all fare revenues are transferred to the authority which selects the
operator offering to provide the service required for the lowest gross cost. The contracted payment to
the operator is that contained in the bid. The services are fully specified in the contract, which may also
contain penalties for failure to operate the required services (e.g., penalties for late running or missed
trips). The operator carries no revenue risk (i.e., has no incentive to generate traffic, through high
quality services) though in this case it does carry all of the operating cost risks. The gross cost scheme is
used in some UK areas and in New Zealand, for example.
On the other hand, the net cost contracts are also known as minimum or net subsidy. The operator
keeps the revenue and receives an additional sum from the authority. Competition for the franchise is
based on lowest amount (typically a fixed sum) requested from the authority. The authority carries no
risk, excepting operator default or failure, while the operator carries the cost and revenue risks, though
he has some guaranteed income. Hence the risk to the operator is slightly lower than under a
commercial operation since some income is guaranteed. Net cost contracts are used in some UK
contracts currently and will be used for all franchises in London from 1997 onwards (Table VII).
The past studies [13] stated that drawbacks of gross cost contracts are extra monitoring costs and
difficult revenue collection mechanism. However, in Seoul case, these two drawbacks might have
minimal impacts on deciding the contracting scheme. First, vigorous monitoring is need anyway for next
5–10 years, to restructure the industry since small and family-owned managements are still dominated in
Seoul bus service. Secondly, fare evasion is less likely to happen in Seoul buses and transparent revenue
collection is relatively guaranteed due to the high usage of smart cards—the 91.5% of bus passengers use
smart cards. Therefore, the gross cost contract is more suitable for the Seoul buses.
Under a net cost franchising system operators are given an incentive to operate a high-quality
service at low cost, and to increase farebox revenues thereby. This incentive should reduce the need for
extensive monitoring on the part of the authority. However where elasticity of demand with respect to
service is low, or where the general trend is away from bus usage, for whatever reason, there may be
incentives for the operator to reduce costs by reducing the level of service provided. In order to ensure
that this does not happen, the contracting authority should monitor operators’ operating behavior.

Table VII. Gross cost contract and net cost contract.

Gross cost contract Net cost contract
Mechanism Where operators takes no revenue risk and Where operators take both revenue cost risk,
receive a fixed income from the contacting sometimes with guaranteed income
authority (minimum or net subsidy)
Advantages Less costly Attracts more bidders Incentive for attracting new passengers
Less monitoring costs
Disadvantages Extra monitoring costs Difficult revenue Attracts less bidders
collection

Copyright # 2010 John Wiley & Sons, Ltd. J. Adv. Transp. 2011; 45:107–116
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 EFFECTS OF REGULATION CHANGES IN SEOUL BUS SYSTEM 115

With gross cost schemes, the operator has an incentive to reduce operating costs (since by doing so
his profits would be increased) but has no incentive to provide a service which attracts more passengers.
Hence gross cost contracts usually contain penalty and, in some cases, incentive provisions to ensure
that the service specified in the franchise is actually run. The authority also monitors operations closely,
whether by using its own checkers or through a second contract for monitoring.
Where monopoly/area franchises are awarded (i.e., where the operator is not subject to any on-road
competition) the net cost operator has an incentive to provide passenger responsive services and
thereby increase his ridership. As noted above, as long as there is some elasticity of demand for bus
transport (with respect to quality), the operator would have an incentive to increase the quality of
service so far as this increases his profits. Hence only where the net cost operator has competition for
passengers (i.e., where there are overlapping contracts) would extensive monitoring be required to
prevent predatory operating practices. In contrast, under a gross cost scheme the incentives are not
altered by the level of on-road competition and detailed monitoring is required regardless.
Therefore, the gross costs with incentive can be very effective to provide the operating incentives
such as vehicle-km with a contracted rate per passenger carried. The gross cost contract with incentives
is the variant of the gross cost, contract revenue is still transferred directly to the authority but operators
are remunerated on the basis of a contracted rate per passenger carried, the level of which is the
criterion of competition. This gives the operator incentive to operate services to maximize their income
by attracting new passengers. In this case, the operator carries some of both cost and revenue risks.
Currently, the basis of contract payment of Seoul buses is determined a sole factor of kilometer
supplied. The fixed rate is determined by, for example, vehicle-km supplied and a variable rate or
incentives can be added such as with a contracted rate per passenger carried or per service hour. The
examples of gross costs contract with incentive can be easily found. In the case of London buses, the
fixed rate is determined by the kilometer supplied and the 15% of contracted cost can be awarded as
incentive based on the reliability performance, while the 10% of contracted cost can be deducted for
poor performance.
Seoul is a mega city with population more than 10.4 M and has a dense and elaborated transit
network. One out of four people in Korea live in Seoul. Therefore, one must utilize the network
economies.
The tendering scheme must offer a network packages as well as an individual route contract. The
network package combining several routes originated from the same garages permit relative large
companies—the maximum number vehicle owned is around 150–250 to enjoy scale economy and
scope economy; while a route-by-route bidding will encourage smaller firms to enter the market easily.
Public authority should establish two separate contracts, one for operation and one for vehicle lease,
which held major benefits. With this contingency planning, the operation contactors can be controlled
more easily, even terminated and replaced, without loss of vehicle availability for a replacement
contract [14]. Although the life cycle of bus become shorter for the environmental requirement and
the sales or/and the transfers of buses are easily done, the public ownership of buses would increase
biddings from smaller firms. It is also best to have the term of the lease contract much longer than the
operation contract, which will maximize the price that has to be charged for vehicle depreciation costs
without obligating the public authority to excessively long operation contracts.

5. CONCLUSIONS

One of crucial measures introduced under Seoul Public Transport Reforms 2004 was the regulatory
framework change of intra-urban bus from the poorly regulated private operations with operating
subsidy, towards the highly regulated one via fixed-price contracts. In this paper, we investigate the
challenges and issues under the new regulatory scheme and propose some strategies that must be
implemented to counterpart them.
Although Seoul Public Transport Reforms 2004 was a success in many aspects, the dated laws and
regulations prohibit the further success such as the judicial precedent of an excusive right-of-way of
operating a route virtually made the monopoly franchise operation with a permanent contract. The
controlling excessive capacities and the change of the nature of labor relationship became the huge

Copyright # 2010 John Wiley & Sons, Ltd. J. Adv. Transp. 2011; 45:107–116
DOI: 10.1002/atr
116 S. KIM AND E. SHON

challenges in last 3 and 4 years; while the controlling subsidies increase by introducing the bulk
purchase of oils and materials, raising fare, etc., has shown some success.
Several actions and strategies must be implemented to overcome those challenges. First, amending
the monopoly operating rights will grants more substantial route restructure and the reducing excessive
capacities. Secondly, the government inventions such as yardstick regulation, more sophisticated cost
estimated and extended incentives and penalties must be adopted to control cost increase as well as to
introduce competition.
The current non-competitive bus contracts such as a sole-source negotiation procurement must be
modified into competitive tendering to induce market-driven restructure. For more successful
regulatory reforms, the SMG needs to set high standards, do the continuous monitoring and conduct
detailed evaluation despite high monitoring costs for next 5–10 years.

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Copyright # 2010 John Wiley & Sons, Ltd. J. Adv. Transp. 2011; 45:107–116
DOI: 10.1002/atr