The Limits of Supply Side Economies of Scale

After two centuries of scaling up, both through market mechanisms and regulatory intervention, supply-side economies of scale might have reached their limits. Scale in transport has limitations that are being confronted by large market players. For instance, growth in container ships seems to be stopping. The largest ships can only operate in the largest ports and cannot use certain routes, such as the Panama or the Suez canals. Furthermore, such large ships are difficult to operate and prone to accidents in ports. In aviation, scale also has its limits: the Airbus A380, with capacity for up to 868 passengers, has turned out to be a failure.

Furthermore, economies of scale are not present in all transport modes. For example, road transport offers limited possibilities in terms of larger vehicles, as road standards do not allow very large trucks. This is why the truck industry is highly fragmented, even in large and mature markets such as the US or Europe. Trucks represent more than two-thirds of the value of freight that is moved within the US - twice as much as rail, air, waterways, and pipes combineds-but truck operations are highly fragmented, with thousands of active companies. The most obvious example of fragmentation is the taxi industry. Thousands of independent taxicabs circulate within the world’s large cities. No coordination exists. Taxi drivers are not aware of the location of potential passengers, so they cruise the city looking for potential passengers who might wave their arm to hail a taxi. Hours of empty runs are wasted, unnecessarily consuming fuel, while increasing the cost of operations. Passengers are frustrated, particularly at peak times (when raining or after a show or sport event) with long waiting times and uncertainty.

Regulatory intervention in the form of legal monopolies, the guarantee to exhaust economies of scale, has proven to have downsides. Monopolies, either state-owned monopolies or privately regulated monopolies, have little incentive to curb costs, to innovate in the provision of services, or to improve efficiency generally. Over the past decades, economists have challenged the assumption that all transport infrastructures and activities are natural monopolies.

Competition has proven to be possible and sustainable in transport modes that were monopolized for decades. This has been the case in air transportation. New airlines have entered the market, which have been stricter with costs and have innovated thanks to new business models, such as point-to-point low cost services, to the benefit of passengers. The industry has been horizontally fragmented, as newcomers have been allowed to enter the market and more companies could provide services.

In other transport modes, natural monopolies have come to be accepted in certain segments, which leaves room for competition in other segments of the industry. This seems to be the case in railways. Regulators in the European Union have accepted national monopolies for the management of the railway infrastructure, but they are opening the provision of transport services over such an infrastructure to competition, both in passengers and freight transport. The industry has been vertically fragmented, as separation of infrastructure management and transport service provision has been mandated.6

Overall, regulatory intervention during the past decades has fragmented the transport industries, both horizontally and vertically, and scale is no longer a goal in itself. Regulation has sought to build a more nuanced combination of efficiencies derived from scale with efficiencies derived from competition.

Finally, a more structural limitation of supply side economies of scale can be identified. Network effects emerge in dense routes that pool together large volumes of passengers and goods. However, first/last mile transport rarely generates enough volume to create supply economies of scale. Scale creates benefits when, for example, passengers traveling between large cities pool together in a high-speed train with more than 500 seats, but not when moving from a home in the suburbs to the local train station.

Flexibility is required to meet the requests of first/last mile transport. Road transportation is often necessary to reach hubs. Passengers often need a dedicated vehicle (usually their own car) to reach a high-speed train station (or even the local train station to commute to the high-speed station) or airport. The same problem exists for freight transportation. Large container ships or large railway freight trains can be efficient for the transport of large volumes of goods, but when goods have to be picked up in the factory or delivered to the commercial center (or, even worse, to the purchaser’s home in the case of e-commerce), smaller trucks are necessary, as volumes do not justify large-scale transportation.

Scale on the supply side does not provide a solution for the coordination of first/last mile transport with large-scale transport in dense segments. This is the main limitation of transportation in the twenty-first century. Large transport providers are focused on improving the efficiency of their operations, but they only cover a segment of the overall transport needs. Concentration of scale in hubs creates a structural problem of congestion around the hub. It is a challenge to park the car in a high-speed train station, or even in a local commuting train station, not to mention an airport. It is a challenge for a truck to get in and out of a large port. The transition from first/last mile transport to backbone transport, particularly if intermodal, is slow, expensive, unreliable, and uncomfortable. It is often an adventure, just as it was for Phileas Fogg.

Coordination and inter-modality are so poor that users often avoid it all together. Once passengers have their own car, they do not merely use it to reach the hub (the train station), but they often use it to travel door to door. They use it for daily commutes, creating congestion in urban areas. They use it for long-distance trips, raising the cost of transportation and damaging the environment. The same occurs with freight transportation in medium distances. Once freight is loaded in a truck, it might simply head to its final destination rather than to the next charging station for transshipment.

The limits of our current transport system, particular the limits of scale in the supply of transport services, might well have been reached. The transport system, as it is designed, neither meets the passengers’ nor the shippers’ demand of door-to-door seamless transportation.

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