Economics: Differential Rail Pricing Employed by a UK Rail Company

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Differential Rail Pricing Employed by a UK Rail Company: A Case Study in Price Discrimination

Introduction

The discussion is about Virgin Trains and its joint venture with the Stagecoach Group.  The focus will be on the Virgin Trains East Coast line which operates between London and Edinburgh.  East Coast has a market share of “just over 30 per cent” of the public transport market including airlines which are also in competition with the railways (Symon 2017). The discussion will focus on Virgin’s ability to vary its pricing between peak and off peak periods of the day.  It also has the technological ability to charge different prices according to how far in advance the passenger is booking.

Discussion

Virgin has managed to successfully increase the number of passenger journeys by exploiting their dominant market power through price discrimination. Business travellers pay more for their rail tickets while leisure travellers tend to pay less because they can be more “flexible with their travel plans" (Bamford 2006:86).  The offer of cheap fares has been used to fill the trains during off peak periods.

Price discrimination has been used by Virgin to segment the travel market so that revenue can be maximised.  There is a difference between the peak (commuting) period where the price elasticity of demand is inelastic and the off peak (leisure) period where price elasticity is price elastic (Bamford 2006).  Under price discrimination, the monopolist rail company assumes that some business travellers are willing to pay a price above a level where marginal cost equals marginal revenue.  The monopolist rail company (Virgin-Stagecoach) seeks to “maximise revenue and generate excess profit” (Bamford 2006:69-70).  It is for this reason that the monopolist does not want to charge a single price.  Instead, they will segment the market and charge more to consumers who are willing to pay extra to travel at the peak period.

Virgin will want to maximise its load factor, which measures its ability to sell all of the available seats on the train (Begg and Ward 2009). The train operation is a fixed cost and operates regardless of whether there are no passengers or whether the train is full.  There will still be fuel and staffing costs which do not vary according to the number of passengers. It is necessary for Virgin to sell as many train tickets as possible to offset its costs.  Demand theory suggests that additional demand can be generated from lower prices. If a passenger wants a train ticket 3 months in advance then they can purchase one for a low price.  This is because there are many seats available and Virgin wants to make sure that they achieve a sufficient level of sales. Once a sufficient level of rail sales has been obtained then they can charge a higher price to later ticket bookers.

Conclusion

Economic theory predicts that rail companies will operate a policy of price discrimination.  This theory can be seen to operate empirically as rail companies will discriminate by time of day or by earlier or later bookings.

Price discrimination, Microeconomics, Khan Academy

An example based on the market for wine.  If a seller has enough market power, it can charge separate buyers, different prices, based on their willingness to pay.