Intercity bus and rail services: Competition and welfare effects

We study the effects of the deregulation of intercity bus services in Europe on intermodal competition in long-distance land passenger transport and on social welfare. We consider a bus company with a flexible (Internet-based) business model and a rail operator with a rigid cost structure due to indivisibilities. We adjust the standard location model of horizontal differentiation to account for quality differences between modes, and for a bus capacity limit. We show that deregulation may turn the former rail monopoly on a route into a bus monopoly, particularly if bus quality is high enough and/or bus marginal cost is low enough. Since the bus is capacity constrained, then social welfare may be improved through a lump-sum transfer from bus to rail to restore competition and increase the number of travelers. Instead, we show that intermodal competition may reduce welfare (compared to rail monopoly) if the bus is inefficient and/or of low quality, so that bus services should be restricted by imposing quotas or even entry bans. Finally, we relax some assumptions and calibrate the model with data from the Genoa-Milan route in Italy. Numerical simulations confirm theoretical predictions and estimate annual welfare gains on the route under the compensation scheme.