Essays on competitive contracting: An application to the mass transit industry

Public mass transit firms have experienced dramatic increases in costs and deficits during the past three decades. In an effort to reduce costs, many of these firms have experimented with competitive contracting of their service operations. Using a panel of more than 300 U.S. transit firms operating motor bus services from 1993 to 1998, I find significant cost-savings attributable to contracting. Unlike previous studies, my analysis controls for both unobservable firm characteristics and the endogeneity of the contracting decision. Cost-savings are estimated at 15 to 19% of operating costs or at least {dollar}4 million for the average public transit firm. In modeling the firm's decision to contract, I also determine that firms act strategically in adopting contracting. Firms are more likely to contract when internal labor is highly unionized relative to external private labor and when the contractor's bargaining power is low. Diseconomies of scale also play a role in the decision to contract.; The estimate of 15 to 19% cost-savings for motor bus services is an average for all transit agencies engaged in contracting. However, not all transit agencies implement contracting in the same manner. Some agencies use fixed-price contracts while others use cost-plus contracts. This variation in implementation may affect the level of cost-savings experienced by a particular transit agency. Bargaining power, scale, and asset specificity increase the likelihood that a transit agency chooses fixed-price contracts. Contracting experience (or potential for repeated contact) and product heterogeneity increase the likelihood of a transit agency using cost-plus contracts. A propensity score approach was used to match fixed-price contract users to similar cost-plus contract users. Although motor bus operating costs were not invariant to contract type, matched firms which face favorable contracting environments were able to achieve similar cost-savings with either contract. For example, firms with greater contracting experience or with greater potential for repeated contact with contractors were able to benefit from cost-plus contracts' greater flexibility without sacrificing the cost-savings commonly associated with fixed-price contracts.; It is important to keep in mind that, unlike private firms, transit agencies are not primarily concerned with profit-maximization or cost-minimization. Rather, the focus is on the social goal of maximizing ridership perhaps subject to a budget constraint. Contracting may be at odds with this goal. Theoretical evidence suggests that there may be considerable trade-offs between contracting's incentives for cost-savings and quality. Given transit ridership's (i.e. demand's) sensitivity to quality measures, such a trade-off could have a detrimental impact on transit's primary goal of ridership maximization. An analysis of service-quality levels, taking into account heterogeneity and endogeneity, indicates that motor bus vehicle miles decline by as much as 16% due to contracting. Safety on motor buses suffers as well. Roadcalls increase by 36% and collisions by 70%. Although these increases in collisions and roadcalls did not culminate in significant increases in injuries or deaths, the results are nevertheless worrisome. The negative impact of contracting on service-quality was traced through to calculate an impact on demand. The 16% decline in vehicle miles reduces transit demand by more than 10% for both passenger trips and passenger miles. The results support the hypothesis that there is a trade-off between incentives for cost-savings and quality. More importantly, the findings reveal considerable side-effects due to contracting that limit both its applicability and value to the mass transit industry.