Before deregulation the bus industry was finding that operating costs, fares and levels of subsidy were on the increase. Almost all companies suffered from a shortfall between revenue from fares and their operating costs. Following the Transport Act 1968 and the Local Government Acts of 1972 and of 1973, local authorities played an increasing role in sustaining public transport through revenue support payments, in line with their statutory obligations to provide coordinated public transport to meet the needs of their populations.
To retain the network of services and maintain fares at acceptable levels, local authorities were asked to make good the losses by subsidy payments. The level of support provided varied considerably from area to area. Because of the extent of cross-subsidy between routes, it was often difficult to assess the value for money obtained. Bus services in large parts of rural Britain, together with many commuter-based rail and bus networks in the conurbations, continued in existence only because of the subsidy paid by local authorities and the urban Passenger Transport Authorities (PTAs).
The Conservative government, committed to reductions in public expenditure and an increased role for commercial objectives, developed policies to reduce subsidies to buses, to reduce the role of local government in planning and controlling bus systems and to increase competition between bus companies. It decided that the way to deal with the decline in bus services, rising costs and increasing subsidies was to deregulate the industry and allow services to be subject to competition as before deregulation it was, in effect a monopoly.
Monopolised industries virtually always produce at a non-efficient level in order to profit maximise (see fig 1). The monopolist will maximise profits by producing where the marginal cost (MC) meets the marginal revenue (MR) because that is the last unit that will make a profit. However it will base its prices on its average revenue (AR) (which is also demand (D)) charging price p whist only producing at level q, meaning that it is making the abnormal profit pqr.
Although this is not a perfect model for the UK bus industry as it was regulated and so had to provide a certain number of bus routes, the general thinking was that it was still allocatively inefficient because there was no real pressure on anyone to produce at their most efficient level. If a division was not making a profit then the government would just bail them out by pouring more money in. This is why the government decided to deregulate the industry. The licensing authorities, the traffic commissioners, lost many of their former powers. Once the Act was implemented, any licensed bus operator merely needed to register its intention to set up a service with the traffic commissioner responsible for the area; the same applied if the operator wanted to leave the industry.
In the beginning many of the senior managers staged buyouts of the firms that they worked for; borrowing millions of pounds to create a very fragmented industry made up of a lot of small firms. This made the original deregulated industry a perfectly competitive market meaning that firms would be forced to provide an efficient service and that it was not possible to make abnormal profits, which is what the government had planned. However it soon appeared that the firms were not making enough money to even cover day-to-day running costs let alone start to take a return on their original investment.
This led slowly to a few big firms starting to take over the industry, buying out the small firms that were under too much competition to be able to survive, pushing the market towards an oligopolistic structure, which would not be efficient either, except that there are very few barriers to entry and exit, making the bus industry a contestable market. There are not necessarily a large number of firms, however they have to remain efficient because of the threat of firms entering the market having sunk very few costs, and taking business from them. All in all the process of deregulation has been fairly successful, the decline in the numbers of people taking journeys on buses has slowed, the industry is under more competition, and despite the fact that a few large firms are starting to dominate the industry, because of the low sunk costs and low barriers to entry and exit, they should not ever have too much monopoly power.