Risk, Regulation and Innovation

In the second of a three part series, TSC CEO Paul Campion looks at the UK’s place in a global race towards a service-based transport industry and why risk aversion and regulation limit innovation.

In my last blog post I talked about the future shape of the transport industry. Both logic and market forecasts predict that transport services will grow faster than the traditional segments of infrastructure and vehicle manufacture (although these segments will remain vital parts of the UK).

The UK has many innovative companies who are delivering transport services today; but what is holding them back from taking an even stronger global lead?

To answer the question, we should be a bit more specific about what we are talking about.

A global race to a service-based industry

The Transport sector is huge. Transport is the single largest portion of consumer spending in the UK (14% which is larger than the average cost of housing, food or clothes). Meanwhile, 10-15% of the costs of all products and services goes on transport bringing together the raw materials and shipping the finished goods to market.

‘Transport services’ can cover everything from shipping raw materials, components and finished products around, to business travel, airline tickets, bus, train or taxi services and transport associated with other services like ambulance trips.

In addition, there are the specialised services used by the transport industry or other companies such as consultancies, designers and planners.

Many companies that we think of as manufacturers sell services. Rolls-Royce is a famous example of a company known for making products (aircraft engines) that sometimes sells them as a service.

Increasingly companies like the automakers are seeking to enter adjacent markets (such as leasing, rental and similar ‘car-as-a-service’ models).

Meanwhile, the companies who make and maintain infrastructure have long been working in various contractual arrangements that deliver the asset as a service.

So, if all these companies are already in the transport services business, you may be asking, what’s the problem?

The problem is that there is a global race to adopt new technologies to deliver better transport services. If the UK environment does not encourage and support UK companies to do so first, they risk becoming uncompetitive, losing export opportunities and being pushed out by foreign companies. It also means the UK will not benefit from innovation as soon as other countries, making the UK economy less competitive as a whole.

Regulation

One of the key characteristics of the transport market is that it is highly regulated. Much of this regulation exists to ensure that transport is safe. The UK has about the safest national railways in the world and air travel is the safest way to travel that there is, on a per passenger mile basis.

Regulation also helps the disadvantaged play a part in society (the mandatory provision of bus services on uneconomic routes, for instance) and helps maintain a wider range of transport options than the market would provide if left to itself.

Regulation also safeguards the working conditions of the people working in the transport industry, not just for the sake of those workers themselves, but also to reduce possible risks to other people if lorry drivers, for instance, were to be required to drive for excessive periods without rest.

However, not all of the impacts of this regulation are positive. It is very difficult for regulators to keep up with changes in technology, land use and society. There is also the fact that a large amount of the demand in the transport market is delivered through the public sector.

Risk Aversion

Most of the infrastructure is owned and built by the public sector and public transport is either delivered by public sector bodies or by private sectors companies that are in contracts that are so tightly regulated that their behaviours exhibit many of the characteristics of the public sector.

Now there is nothing at all wrong with the public sector and I am not arguing for or against public ownership per se. The issue is that the public sector is highly risk averse (and, as taxpayers, we might all agree that that is a good thing). It will regulate for, and will procure, services that are proven and that have demonstrated the best value for money (however that is measured).

On the other hand, the services companies themselves are highly competitive with each other. In order to win business from the public sector, or in the context of a highly regulated private sector, they need to offer a low risk, reliable service at a lower cost than the other companies bidding for the same business.

The nature of a services business, though, is not the same as a manufacturing business. In order to sell me a car a company must design, test and build that car before it can offer it in the forecourt.

The services companies, however, cannot afford to stand up a complete services offering (such as a rail franchise) before they win the business. They can specify their services in a bid but, as a generalisation, they will not need to invest in all the resources to deliver it until they have won the bid and some competition will ensure that they cannot afford to do so.

The combination of these two characteristics means it is hard to innovate in regulated services delivery.

The competitive forces on the companies means they cannot develop new services until they have won a contract for them, but the organisations specifying or buying the services cannot take a risk on something new because it is not proven to be the best value for money and will not be perceived as low risk.

In my next post I will talk about how we might get around this ‘deadly embrace’ that is restraining the UK transport services industry from innovating as quickly as it could.

Read the next blog in this series “Unleashing Innovation in the UK” here

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