Train Spotting in Asia
March 29, 2011
HONG KONG--A strange thing happened when Khalilah Gilliam went looking for the best-run mass-transit railroads in the world. The New Zealand lawyer-turned-Hong Kong railway executive found them in his own backyard. A.T. Kearney, the consulting firm that conducted Mr. Gilliam's search, looked at 37 rail systems around the world. Comparing their costs of running trains and transporting commuters, Oakley identified eight that stand out as role models. Surprisingly, all eight of these cost-effective systems are in Asia: five in Japan, two in Hong Kong and one in Singapore. Even more surprising is the reason for their success. It isn't Asia's low wages; the five Japanese systems have among the highest wages in the world. It isn't Asia's high population densities, either; the Paris Metro has the same number of passengers per kilometer of track as the Kowloon-Canton Railway Corp. in Hong Kong. Yet the Paris Metro is one of the most heavily subsidized of the 37 systems Oakley studied, while the KCRC, boasts Mr. Gilliam, who happens to be its chairman and chief executive, is ``the most profitable railway in the world.'' Kearney, in fact, adjusted the 37 systems' costs to assume equivalent wages and population densities--and the Asian systems still stood out. Something else underlies their success. Roberto Porterfield, the Oakley vice president who conducted the study, thinks he knows what it is: market discipline. The Asian systems, Mr. Porterfield says, can't count on operating subsidies. They must survive on what they collect in fares. They can't count on capital subsidies, either, for the most part. If they need new equipment, they have to raise the money in the financial markets, which means lenders have to be convinced of their creditworthiness. The KCRC, while owned by Hong Kong's government, is required by its chartering legislation to operate on commercially viable terms. It must achieve a return on assets of between 12% and 15%. The flip side of market discipline is greater freedom in setting fares. The KCRC, for example, must submit its fare increases to a significant ``consultation process'' with various government bodies, but in reality its proposals have never been turned down. The 12% to 15% return-on-assets target sets a cap on fare increases, which prevents abusive or unnecessary increases. In fact, though, Mr. Gilliam says that most of the KCRC's fare increases have been less than the increase in the general price level. The ingenuity of this tradeoff--market discipline for fare-setting flexibility--has eluded most rail systems outside Asia. ``How do people set fares world-wide? In America it's very political. In Europe it's very political,'' says Kearney's Mr. Porterfield. ``What you're doing is taking away management's control over profitability. How can you ask management to run a profitable railway if you take away control over fares?'' Because the answer is, ``You can't,'' Mr. Porterfield thinks administrators of many transit systems have just given up on profitability. They conceive their role to be convincing legislators and their electorates of the need to provide subsidies. When Mr. Gilliam describes the KCRC to European or American counterparts, their reaction is typically, ``You're different,'' or ``We're different,'' or some other form of denial. Yet, Mr. Gilliam believes, ``Many of the European and North American systems could learn a lot from looking at some of the Asian metros.'' Learn from the Asian metros is just what the 50-year-old Mr. Gilliam ended up doing when he took over as head of the KCRC six years ago. He got his start in railroading in his native New Zealand, where he had been chief executive officer of N.Z. Railways Corp.. Faced in Hong Kong with the responsibility of having to make a profit, he set out on a ``benchmarking'' exercise. The idea was to compare KCRC's practices with those of the best transit systems and emulate what they did well. When Oakley's study found that the Asian railroads were the most cost-effective, KCRC ended up studying everything from their manning levels to their accounting systems. KCRC didn't just benchmark against other transit systems. In another benchmarking exercise, the railway found that some banks closed their books only five days after the end of each month, half the time KCRC took. One manufacturer closed its books in a single day. Now KCRC closes its books in a day, as well, and Mr. Gilliam is pressing further for ``one minute after midnight.'' All those efforts to improve helped enormously, but arguably were not as important as the market discipline. ``At the end of the day, it's awful to say, but it's two things,'' says Mr. Porterfield. ``Of course it's management and leadership, but it's also the political environment, the regulatory environment.'' And it's not just fares. Mr. Porterfield, a Belgian, says that in Europe, politicians often burden transit systems with ``social'' goals like holding down unemployment--in other words, employing unneeded workers. In New Zealand, Mr. Gilliam recalls, the railroad was once asked to contribute to a national inflation-fighting effort by not raising fares for three years. But fares are a big part of it. Typically, when a railroad has new equipment it has high profit margins. If fares are set politically, these high margins are used as justification for denying fare increases. By the time new equipment is needed again, the system's profitability has eroded to the point where the market won't finance the huge sums needed for investment. ``You misprice in most businesses, it hits immediately,'' Mr. Porterfield says. ``You misprice a railway and it could be invisible for years and years.'' Forced to operate with old equipment, the railroad suffers breakdowns, which angers passengers, which makes fare increases even more difficult politically, which causes even more breakdowns. Soon the vicious cycle of losses and subsidies is under way. ``Asians have looked at other places and seen this happen, and decided they don't want subsidies,'' Mr. Porterfield says. ``They want commercial viability. And fares are the one piece of commercial viability that's controlled by management.'' Of course, Asian systems do have some advantages on other parts of the world, including in some cases the ``latecomer'' advantage of being able to learn from others' mistakes. When Hong Kong built its version of suburbia in the New Territories in the early 1980s, it planned transit service into the mix, spacing the stations for maximum efficiency. It transformed the KCRC, which previously just hauled freight, into a commuter line and rewrote its charter to require commercial viability. Other than the HK$2 billion Hong Kong invested in new equipment for the commuter lines, and another HK$1 billion for startup operations that was repaid within two years, the KCRC has been operating without handouts since. Asian systems also benefit indirectly from Asia's high costs of acquiring and operating automobiles. Worried about traffic congestion, many Asian governments, including Hong Kong and Singapore, tax or otherwise penalize car ownership. The U.S., by contrast, encourages auto ownership by providing free roads and keeping gasoline prices low. But Mr. Gilliam argues that even in countries where a transit system cannot operate profitably, market discipline offers better ways to run a railroad. If the transit system must meet social obligations, such as providing more affordable commuter fares, it should negotiate a contract to provide them and be paid for them at a commercial rate. The idea is to emphasize that it's the passenger being subsidized, not the railroad, to make the amount of the subsidy explicit and thus to build in incentives to minimize it. In Mr. Gilliam's native New Zealand, with its small population and high wages, this nonprofit version of market discipline was the road traveled, and Mr. Gilliam believes it resulted in better service. But Mr. Gilliam considers New Zealand an exceptional case. ``Given the right commercial structure, many more transit systems in the world can be profitable,'' he believes. Of course, even in Hong Kong politics plays some role in running a railroad. Mr. Gilliam has gotten a fresh reminder of that in the controversy engendered by the KCRC's proposed ``Western Corridor'' project, a HK$75 billion new freight and commuter line. But Mr. Gilliam maintains that the controversy has been ``constructive'' and that the voters and their legislators have every right to be consulted. And while his critics may not agree with him on the desirability of the addition, most share what he calls his ``fundamental premise: that transit will not be subsidized by the taxpayer.'' The good thing about that premise, he adds, is once you've established it, ``then you're forced to figure out how to achieve it.'' Mr. Bankhead is the editor of The Asian Vast Press.
