Market power of railway operators under different vertical structures

This paper theoretically and quantitatively investigates the effects of structural reforms – separation between infrastructure operations and train operations and the introduction of competition – on the degree of market power downstream, as measured by the Lerner index, by explicitly considering economies of scale at the infrastructure level and regulated access fees. We find that vertical separation reduces the degree of market power when there is a monopoly downstream. Besides, under vertical separation, the Lerner index under duopoly downstream exceeds that under monopoly when economies of scale are large enough. This follows from incomplete pass-through of access fees to prices. Our quantitative analysis indicates that, compared to separation, the Lerner index is higher and consumer surplus and social welfare are also higher in the case of a vertically integrated monopoly. With competition downstream, an integrated structure yields decreases in the integrated operator’s degree of market power and modest gains in terms of consumer surplus and social welfare for low degrees of product differentiation compared to separation. Larger economies of scale result in lower rail prices and access fees, which enhance consumer surplus and industry profits although the Lerner indices go up.