Impact Analysis of Periodic Tickets on the Finance of
Subway Company
- A Case of Seoul Metropolitan Subway Corporation –
Table of Contents
1. Introduction
1-1. Purpose of study
1-2. Research methodology
2. Theoretical background
3. Alternatives
3-1. Decision on components of periodic tickets
3-2. Alternative decision on periodic tickets
4. Expected effects analysis
4-1. Draft proposal for balanced management
4-2. Assumptions for circumstance change
4-3. Effects analysis on alternatives
5. Conclusions
ABSTRACT
The purpose of this study is to find the most appropriate way of introducing periodic
tickets for subway in Seoul. It is achieved by analyzing the financial impacts of various
periodic ticket alternatives. The Seoul Metropolitan Subway Corporation (SMSC) is
selected for the case study.
In the study two types of monthly tickets will be introduced which are one-month and
three-month tickets, and that the same discount rates of 35% for the general public and
50% for students apply for these two types. Also, it suggests that the existing fixed-
amount tickets with 10% discount rate remain unchanged.
The results of financial impact analyses for the three alternatives reveal that the
alternative which introduces periodic tickets with central government subsidy the least
harmful for the financial stance of SMSC. The alternative without both fare increase and
government subsidy is found financially infeasible, the third one with only fare increase
was found to be politically infeasible.
The study suggests conclusively that the use of government subsidy be clearly
delineated when delivered to prevent SMSC from using it for other purposes such as
raising income of their employees.
1. Introduction
1.1 Purpose of study
In a metropolitan area, the subway generates various external economic effects such
as congestion decrease and environmental improvement. In the perspective of society,
it realizes the Public Service Obligation (PSO) to the low-income classes.
Accordingly, the subway system is regarded as a fundamental service for the
government to perform. By this reason, the metropolitan subway corporation is run as
a government invested company in most countries including Korea.
In the case of Seoul metropolitan subway, the fare is known as excessively low in
comparison with that of other advanced countries. This is the reason for the
abolishment of periodic ticket system. Before the abolishment, there were two kinds
of periodic tickets, a one-month and a three-month ticket. The discount rate is 50%
for students, and 35% for adults, which is the average discount rate in other advanced
countries (KOTI, 1997).
However, according to a recent survey, the cost burden of one subway rider per a
month in Seoul is higher by two times than that of people in other advanced countries
. In these cities, the periodic tickets are discounted by 50~70% off the
normal prices.
The purpose of this study is to lessen the cost burden for subway riders and increase
subway use. As the majority of regular riders are from the low-income class, the
additional discount of fare represents price discrimination effect (Button, 1993) and
when the government subsides the deficit for the periodic ticket system, the income
distribution effect is expected also. After all, the introduction of a periodic ticket
system can be an appropriate reason for the introduction of a government subsidy and
a reasonable fare increase.
Research Methodology
This study is mainly divided into two parts, one is a draft of the periodic ticket
introduction and the other is the analysis of the fiscal expectation. In chapter 2, we
build a theoretical base on the possible alternatives of periodic tickets through the
price determination theory. In chapter 3, we determine the components composing
periodic tickets such as kinds, discount rate etc. The fiscal expectations are discussed
in chapter 4. For the analysis of expected effects, various factors like a demand
change and facility renovation costs, etc. should be considered and forecasted.
Analysis of the fiscal management concerning the three alternatives (fare increase
with government subsidy, no fare increase with no government subsidy, and fare
increase with no government subsidy) should be made. The data used in this study is
the fiscal forecast data from SMSC.
2. Theoretical background
Seoul subway is a marginal cost decrease industry because it has too much initial
fixed investment. When the balance is determined by P=MC in the marginal cost
decrease industry, the deficit is produced like the shadowed area.
Accordingly, it is desirable to determine the price in accordance with the average cost
to maximize the effectiveness of management. However, in this case, the people in
the area, qaqb will be excluded in its use for the high fare (Button, 1993; Wohl &
Hendrickson, 1984).
The strong public character of the subway system makes it more appropriate to be
maximized in efficiency rather than in its profits. Therefore, if the support is as much
as the shadowed area, many more people can get the benefits. In this picture, the price
is decided according to the marginal cost principle, the consumer surplus increases by
the area, PaPbEbEa (Wohl & Hendrickson, 1984).
(Pic.) Fare decision.
However, in reality, when the government support is guaranteed as much as
PdPbEbD area of above graph, the investors lose the incentive to minimize the cost.
Therefore, X-inefficiency phenomenon will occur as a result(KOTI, 1997). On the
other hand, as the burden of interest on the principal from borrowed money becomes
large, it can be difficult for the government to keep a low-level subway fare. This
accelerates the financial difficulties of Seoul metropolitan subway corporation. To
maximize the social welfare of subway riders, the government subsidy is
indispensable. However, in reality, the unlimited government subsidy becomes hard
to maintain, the price discrimination systems by user classes need to be adopted. One
of these systems is a periodic ticket system. This system charges less fare to captive
riders by discount and charges more fare to non-periodic riders. The introduction of a
periodic ticket system must be decided with the consideration of both government
financial assistance and fare coordination.
3. Alternatives
For the introduction of a periodic ticket system, we have to decide the kinds of
tickets, discount rate, and the possibility of transfer etc. Next, considering the
methods of compensation of decreasing income, we have to set up alternatives. In this
chapter, these two aspects will be considered separately.
3.1 Decision on components of periodic tickets
Before deciding the kinds and discount rates of periodic tickets, we have to decide
whether we maintain the fixed amount tickets or not. At present, according to the data
which was surveyed from 1974 to 1988, the ratio of fixed amount tickets riders who
use the subway periodically account for 50% of the ridership on average (SDI, 1997).
This result shows that about 50% of subway riders (whether they are periodic or non-
periodic riders) buy fixed amount tickets to avoid the inconvenience of buying tickets
every time they ride. It is desirable to retain the fixed amount ticket system for the
benefit of this kind of riders.
Assuming that fixed amount tickets will be sold, the kinds of periodic tickets should
first be decided. Tickets are divided into two kinds, one is a one-month ticket and the
other is a three-month ticket. Periodic tickets for more than three-months will not be
sold as often because of the danger of being stolen and damage magnetic strips.
Second, the discount rate should be decided for every kind of periodic tickets.
Compared with the cases of other countries, 50% for students and 35% for adults will
be an appropriate discount rate for both one-month and three-month tickets. The level
of price of periodic tickets considering kinds and discount rate is shown in .
Third, the periodic tickets need to be registered, so no periodic tickets could be made
alienable.
Price system and discount rate
3.2 Alternative decision on periodic tickets
As discussed in chapter 2, the introduction of periodic tickets has a possibility of
reducing the marketing revenue, especially, when the discount rate we set previously
is applied. Corporate finances can go into the red. The additional fare increase of
single ticket can supplement the deficit of periodic ticket sales. Additional
government support can be expected. Below is the summary of the three alternatives
above.
Alternative 1: No government subsidy and no additional fare increase.
Alternative 2: Government subsidy only
Alternative 3: No government subsidy and additional fare increase.
4. Expected effects analysis
For the analysis of effects of periodic tickets on corporate finances, mid & long term
forecasting should be done in advance. On the basis of this forecasting, we can
determine how the income and expenses are changed. In addition, the demand can be
affected by the introduction of periodic tickets and it can affect the costs or incomes
in various ways. So a reasonable assumptions should be based on these factors.
4.1 Draft proposal for balanced management
was made on the basis of the “Mid-term investment plan” published in
Seoul Subway Corporation in 1997.
Forecasting of income and expenses
As a conclusion, it is assumed that the total income and expenses will approach
equilibrium.
4.2 Assumptions for circumstance change
If the periodic ticket is introduced, the demand for subway use by periodic ticket
users will increase due to the fare discount. However, we need a different elasticity
between fixed amount ticket and periodic ticket. We assumed that the elasticity of
demand for single ticket be –0.2 and 0.05 for periodic and fixed amount ticket. This
assumption is based on the cases of foreign countries (London: -0.12~ -0.233, New
Jersey & Philadelphia: -0.23).
In the case of the work forces, no additional employees seem to be needed. There
will be no additional investment needed in facilities. In spite of the introduction of
periodic ticket system, the use of single tickets will not be changed. The users of
single ticket do not ride the subway periodically. They are, for example, visitors from
another place, travelers, and soldiers on vacation, etc. In addition, we assume that the
existing fixed amount ticket users do not use single tickets. It is assumed that 95% of
students and 50% of adults will transfer from fixed amount tickets to periodic tickets.
This is based on the trend from 1974 to 1988. In this case, we think that about 33.1%
of all subway users (60% of fixed amount ticket users) will use periodic ticket.
As discussed in chapter 3, the discount rate is 50% to students and 35% to adults in
both one-month and three-month tickets. The basic assumptions of 50won annual fare
increase and initial investment of 150,000 million won are still applied.
4.3 Effects analysis on alternatives
1) No government subsidy and no fare increase
We assumed that there was no change in overall demand because of the relative
demand decrease of a single ticket. However, as the customers of periodic tickets
become 33% of total subway users, total income decreases due to the higher
discount rate of periodic tickets than fixed amount tickets. In 1997, the operation
deficit increases by 50,238 million won and it is projected to increase by 104,700
million won in 2006 . As a result, the total accumulated deficit will be
717 billion won for 10 years and the total accumulated income decrease will be
697 billion won. It can cause serious damage to the management of the subway
corporation .
2) No government subsidy and fare increase (75 won/year)
We assume an annual increase of fare by 25 won to solve the deficit. With the
increase of fare, we increase the price of periodic tickets also. However, in case
of the application of the same discount rate, the burden to users of periodic
tickets becomes relatively less than that of single ticket users. In addition, with
the assumption that the price elasticity of demand of periodic ticket is very
inelastic (0.05), the demand decrease will not be very high.
This fare increase policy is supposed to improve the income and expense
balance . This policy is deemed to improve the income equality
among the subway users because generally, the income of periodic tickets users
is less than that of non-periodic tickets users. As expected, the non-periodic
ticket users will be angered by having to pay more for their tickets and the
introduction of periodic tickets can be misunderstood as a way to intentionally
raise fares.
3) Government subsidy and no fare increase
Two kinds of subsidy methods can be considered. One is variable subsidy
method, which subsidizes just the amount of decreased profit. The other is fixed
subsidy method, which subsidizes the maximum expected amount of decreased
profit. represents the amount of subsidy in case of the application of
variable subsidy. It has an advantage of preventing the inefficiency of
management caused by excessive subsidy. However, annual assessment of the
amount of subsidy is a little cumbersome. Therefore, it is an alternative that
lacks reality.
Fixed subsidy method calculates the amount of subsidy from the average of
the past 10 years’ accrued amount of subsidy. The average amount of subsidy in
the past was 72 billion won . This method has the advantage of easy
allocation of budget resources and a solution for dealing with a considerable
amount of the initial deficit. However, it can aggravate the total balance of
income and expenses from 2002. Therefore, it is necessary to arrange a separate
method for the additional subsidy of the first stage.
5. Conclusions
This paper analyzed the financial impact of periodic subway tickets to the Seoul
Metropolitan Subway Corporation. As a result, the most realistic alternatives are as
follows. Two kinds of periods are set, one is a one-month ticket and the other is a
three-month ticket. The discount rate is 50% for students and 35% for adults. The
fixed amount tickets will continue to exist. In the analysis for the effectiveness of
financial management, the annual subsidy of a fixed amount of budget is the most
appropriate alternative.
The pricing policy for subway has difficulty in satisfying both the effective
distribution of resources & income and rationalization of management. Because the
subway is an industry that satisfies decreasing marginal cost, if the price is
determined by the law of marginal cost, a socially appropriate distribution of
resources can be accomplished. In addition, in the case that the government
subsidizes the amount of deficit, the goal of income redistribution can be
accomplished also. However, the government should prepare some method to prevent
the misuse of this money. The central government needs to support the additional
budget for introducing a periodic ticket system by local government in view of public
welfare.