Gross cost or net cost: which bus contract fits your Authority?
The contract form determines who carries the consequences when fares and passenger numbers do not follow the plan.
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Should the Authority retain fare revenue or should the Operator? The decision determines where revenue risk sits and who must carry out the operational tasks.
In a gross-cost contract, the Authority pays the Operator to deliver the specified service and normally retains the fare revenue. In a net-cost contract, the Operator normally keeps the revenue and bids on the income it expects to earn, alongside any agreed support payment. The labels describe a starting point. The detail of the payment mechanism can change the incentives.
A gross-cost arrangement gives an Authority freedom to set fares, alter tickets and join up the customer offer, but it also owns the downside if patronage falls. Under a net-cost arrangement, the Operator has a direct interest in revenue. The Authority has less room to make changes that affect that revenue unless the contract allows them.
The payment mechanism does the real work
The base contract form is only one part of the commercial model. An Operator paid solely for scheduled mileage faces different incentives from an Operator whose payment also reflects reliability, lost mileage, customer information or vehicle condition. The measures must be defined so both parties can measure and check them consistently, and so the contract deals with external events that make a target unreasonable.
Drafting points can have material commercial consequences. If a fare change, diversion or school timetable change reduces receipts, who bears the effect? Does the Authority have sufficient transaction data to distinguish a fall in demand from a problem with ticket acceptance or revenue allocation? When missed journeys are deducted, is there a fair process for recording a road closure, a vehicle failure and an avoidable dispatch error? These are Contract Management questions to settle before the tender is awarded.
London is a useful lesson, with limits
London’s experience shows that the contract label alone does not explain outcomes. Its bus route contracts were gross cost from 1985 to May 1996, then net cost from June 1996 to July 1998. There was a short return to gross cost before Quality Incentive Contracts began to replace earlier contracts as routes were retendered from October 2000. Transport for London retained the revenue under those contracts and used performance payments alongside the core contract price.
London’s review recorded disappointing Operator performance under the brief net-cost model. It does not follow that net cost will produce poor reliability elsewhere. Network geography, congestion, fares, information systems and incentive design all affect the result. If an Authority wants a particular service behaviour, the contract should state the requirement and the financial consequence.
Capability before risk transfer
An Authority considering gross cost must identify what it will run or oversee. Revenue must be reconciled across ticketing channels and Operators. The arrangements need clear rules for refunds, chargebacks, apportioning multi-Operator tickets and income from concessionary travel. The Authority also needs forecasts that it can update when fares, employment patterns or competing services change.
Net-cost arrangements require the same discipline. Authorities need patronage and revenue data to assess an Operator’s proposal, test claims during a contract and negotiate a variation. The headline choice matters, but the practical question is whether the Authority has the data, people and delegated decision-making powers to manage its consequences.
Before considering franchising, an Enhanced Partnership can help Authorities resolve some of those issues. Current government guidance describes an Enhanced Partnership as an agreement between a local transport Authority and the majority of local bus Operators to improve services. It does not remove the need to decide where revenue risk sits. It can improve ticketing arrangements, data sharing and the passenger offer while Operators continue to run commercial services.
ITA’s LiteFranchise™ is a commercial and operating framework for Authorities considering a simplified route to stronger network control. Whatever approach is considered, the proposed payment mechanism should be modelled using the Authority’s actual routes, fares and available data rather than copied from a different network.
LiteFranchise™ is designed to support patronage growth through built-in Operator incentives.
Useful questions
Before choosing a contract form, an Authority should be able to answer the following questions in practical terms.
- What fare, passenger-number and cost risks would transfer under the proposed contract, and which would remain with the Authority?
- Can we reconcile ticketing revenue and apportion multi-Operator or multi-modal tickets with the data we hold or can procure?
- How will you build measurable patronage growth into the scheme?
- Which outcomes should affect payment, and can each be measured independently of Operator self-reporting?
- How will fare changes, diversions, service variations and exceptional disruption be handled without creating a dispute each time?
- Do we have the people, decision rights and budget contingency to manage revenue risk over the life of the contract?
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