The Impact of Ferry Services on an Island Economy: Summary Notes

The Impact of Ferry Services on an Island Economy

Introduction

The paper discusses findings and methodology of a study on alternative ferry fare mechanisms in the Western Isles, Scotland, UK.
The Western Isles are a remote island chain about 55km off the north-west coast of Scotland, stretching 180km from Vatersay to Lewis.
The total population is 26,500, with a low population density of 9.15 people per $km^2$ .
Stornoway is the only town, with a population of around 8,000; the remaining settlements are small and scattered.
Traditionally, the Western Isles relied on small-scale subsistence agriculture (crofting), fishing, and textiles.
There has been a decline in these industries and a rise in the importance of the public sector, tourism, and other service industries.
The Western Isles economy is estimated at £221 million or £7,827 per head in terms of Gross Regional Domestic Product (GRDP).
Main sectors include public services and administration, distribution, fishing/fish farming, agriculture, health, and education (Western Isles Enterprise, 2005).
The islands continue to experience population decline and an aging population.
Over the last century, the population has declined to just over half its 1900 level, indicating long-term economic decline relative to the rest of the UK and Scotland.
This decline is not inevitable, as illustrated by comparison with other island groups, such as the Isle of Man and the Faroe Islands.
These islands have differing political, economic, and physical characteristics, in particular fiscal autonomy.
Fiscal autonomy has allowed them to focus on differentiating their economies to achieve economic growth in ways that may not be open to the Western Isles.
Within Scotland, the Isle of Skye has been able to sustain rapid economic and population growth over the last three decades within a similar geography and the same political and fiscal framework as that of the Western Isles.
This is partly attributable to good transport links with the Scottish mainland, in particular the Skye Bridge, an excellent link which is now toll-free.
Despite a relatively high public subsidy, charges for vehicles on ferries within and to/from the Western Isles remain high as compared with subsidized operators in other areas within the UK and elsewhere.
This study considers how a revised ferry fares mechanism and operating pattern could help turn around the Western Isles’ downward economic and population trend.
This would be achieved through increasing traffic volume and income on island ferry services, thereby enhancing the economic performance of the Western Isles, while minimizing economic subsidy.
Aims of the study:
- Assess the current ferry operation under the existing fare pattern.
- Identify potential ferry fare and operational models that could be applied or adapted to Western Isles ferry routes.
- Assess the economic and social impact of the models identified.
- Recommend the most effective model for stimulating economic growth in the Western Isles.

Ferry Fare Models

Transport planners aim to create conditions for ferry transport to islands and other remote areas (such as peninsulas) that are comparable with those on the mainland.
This means considering the appropriate ferry and shipping links as roads or bridges.
“The car ferry to an island and the piers are, in fact, parts of a flexible road over which cars and commercial vehicles can pass to and from islands.” HIDB (1974)
The concept of “Road Equivalent Tariff” or “RET”, as developed by Pedersen (1974) based on the Norwegian fare system, was based on the idea that payment of road tax entitles road users to drive anywhere on the road system.
Tax is used to construct and maintain roads, which go everywhere, except for reasons of geography to islands and a few very remote peninsulas.
Islanders pay road tax but are uniquely denied access to the great bulk of the road system without paying a substantial ferry surcharge.
Vehicle ferries act as roads between island and mainland.
To be equitable, the cost to the road user of crossing the ferry ought to be related to the cost of traveling along an equivalent length of road.
This would be achieved by charging a vehicle the equivalent of its road running costs when the vehicle is being conveyed on the ferry.
The shortfall between resultant revenue to the ferry operator and his costs would be met from taxation.
Vehicle operating costs can be expressed on a mileage basis and related to the length of each type of vehicle.
A formula was created to translate this concept into a lineal ferry charge.
The formula included a “toll”, equivalent to 4 kilometers of distance; similar to tolls charged to road users for exceptional capital expenditure, such as on certain bridge crossings.
Thus a one-kilometer crossing would be charged as five kilometers, two kilometers as six, etc.
The formula was set out as follows:
$C = L \cdot O \cdot D + T$
or
$L \cdot O \cdot D + 4LO$
Where:
- $C$ = charge for a single journey
- $O$ = operating cost per km, per meter of vehicle length (average)
- $L$ = length of vehicle in meters
- $D$ = passage distance in kilometers
- $T$ = toll element = 4LO
A criticism made was that the application of a formula of this kind detached the charge levied for passage from an exact link with the operating cost of the vessel.
It was in fact doubtful then, that such exact link existed, with the charging regime in force then nor indeed exists now.
As a counter-argument, an analogy can be made of the postal service which does not surcharge island letters and parcels despite the necessity for the cost of sea or air transport.
Ultimately, RET has generated much interest, and continues to do so, but has yet to be implemented in the UK on grounds of expense.
There is therefore a clear need to develop a fare mechanism that provides the equality benefits of a system such as RET, but which can be implemented with the aid of less public subsidy.
Route frequency has economic consequences for island regions.
The experience of vehicle ferry operation in countries such as Norway, has revealed the potential benefits of the “shortest route” principle in reducing fares, operating costs and the requirement for subsidy, while increasing frequency.
To illustrate the point, if a 30 mile (two hour) crossing can be replaced by a (one hour) passage of 15 miles, a ferry would be able to make five or six round trips per day instead of three.
Therefore to carry the same volume of traffic a ship of roughly half the size and roughly half the operating costs is required.
Increased frequency coupled with reduced charges always generates new traffic and a requirement for increased capacity, which in turn provides the potential for growth in GDP.
This paper explores the likely impact of a number of alternative scenarios, with differing fares and frequencies, on the economy of the Western Isles and will inform decision making on the best choice of mechanism to take forward.

The Baseline Scenario: Current Routes and Fares

To put the current fares structure in context it is necessary also to examine the overall characteristics of each route.
The routes are a combination of longer distance and shorter island-mainland routes, together with 2 inter-island ferries.
2003 traffic statistics for each route are provided by the ferry operator for passengers, cars, coaches and commercial vehicles (CVs) and are provided for the summer (29 March to 19 October) and winter respectively.
The current structure of fares and charges is composed of three separate elements for passengers, cars and commercial vehicles, the later including busses and coaches.
There are a number of anomalies apparent in the current fares. For example, the passenger fare on the short (10 km) Barra – Eriskay crossing is more than on the longer (18 km) Berneray – Leverburgh crossing.
Also, the CV rate on the Berneray – Leverburgh crossing is almost as high as that on the Uig – Lochmaddy/Harris crossing, which is over twice the distance.
To calculate operating profit, it is necessary to determine revenue and costs.
Although the ferry operator was in receipt of substantial (around £18m) of public subsidy for the financial year 2002/3, the company is not obliged to publish route by route revenue and cost information.
Therefore it was necessary to construct a model that computes on a route by route basis, current income from fares and other revenue, and then to set these against costs of operation and capital charges.
Starting point was to take published traffic data for each route for the year 2003, and from this to calculate derived revenues based on peak and off-peak single ticket prices for passengers and cars.
Commercial vehicle and coach income for the longer routes was based on an average vehicle length of eleven meters; slightly shorter for the short inter-island routes.
Estimated on-board sales were then added and commissions subtracted.
This total theoretical or nominal total figure was then discounted to 80% of the derived sum to allow for return fares, children, freight discounts, etc.
The total computed revenue for the Western Isles ferry routes is some £13.6 million per annum based on 2003 traffic figures and 2004 fares and charges.
The next element of the modelling process was to calculate the direct operating expenses of each route/ship.
For the most part this is relatively straight forward as the crewing levels are known and wages, social costs, fuel consumption and other costs are based on those that apply in the UK maritime industry and augmented by the consultants’ knowledge, local research and the operator’s accounts.
It should be stressed that as the resulting figures are not based on company data they are, therefore, an approximation of actual costs but are sufficiently accurate for the purposes of comparability.
By subtracting the calculated direct operating expenses for each route from the estimated revenue, an estimate of computed direct operating loss for each route can be arrived at, the total for all Western Isles routes by our calculation being just under £4 million.
The data suggests:
- route frequencies are low
- some timetables inconveniently vary from day to day
- on most routes passenger loadings are low
- crewing levels and costs seem higher than necessary for passenger volumes carried
- crew costs are about a third of all operating costs
- vessel utilization is less than optimum
- fares are inconsistently applied and seem high due to high operating costs
Primary research carried out by the authors also revealed that local residents and businesses see fares as a serious economic constraint and that there is (understandably) widespread support for a moderate (30%) fare reduction and the introduction of a Lochboisdale-Mallaig service.
The data and calculations provide a framework for comparisons with international ferry routes and for considering alternative fare mechanisms and operating patterns for Western Isles routes.

Comparator Routes

One way of identifying alternative fare mechanisms and operating practices with those that currently obtain in the Western Isles, is to look at different approaches taken by governments and ferry operators elsewhere in the UK and internationally.
From the large amount of data assembled from an international selection of routes, we undertook a comprehensive analysis, comparing passage length, single high season passenger, fares, car and CV rates.
The trend line shows Western Isles passenger fares in roughly the middle of the scatter but at the high end of the subsidised routes, and still higher in the case of the short Sounds of Barra and Harris routes.
A similar exercise was performed with peak single car and CV rates for each route with the passage distance, giving similar results.
From the route comparisons it is apparent that there is a distinction to be made between subsidised ferry operations and those operating commercially to maximize profit.
Western Isles passenger fares are around the middle of the comparative range but a high compared with other subsidised routes, and still higher in the case of the short Sounds of Barra and Harris routes.
Western Isles car rates are relatively high compared with all routes and significantly higher than other subsidised routes.
Western Isles commercial vehicle charges are very high compared with all routes and about three times higher than the general trend for other subsidised routes.
The comparisons with ferry routes worldwide provide a framework for considering alternative fare mechanisms and operating patterns for Western Isles routes.

Alternative Fare Mechanisms

Fares systems cannot readily be separated form way services are operated.
The advantage of a cheap fare may, for example be offset by poor timings or inconvenient hours of operation.
In the case of the Western Isles ferry routes the reasons for the differences appear to be linked with:
- a multiplicity of routes, several of them long
- low frequency of service
- inconvenient and variable timetables
- low passenger loadings
- high crewing levels and costs
- un-optimised vessel utilisation
- high fares due to high operating costs
- fares inconsistently applied.
In the light of this we have looked at the task in two ways.
- Firstly: what alternative mechanisms are possible under present operating conditions
- Secondly, what alternative mechanisms are possible under altered operating conditions?
A comparison is made between the present fares regime and ferry services, and the economic impact of five selected scenarios:
- RET under current conditions
- A Tailored tapered tariff (TTT) under current operating conditions
- A reduced fare TTT (TTTR) under current conditions
- TTT under our illustrative alternative operating conditions
- TTTR under our illustrative alternative operating conditions
Each scenario will result in differing levels of increased local resident and visitor expenditure, and increased business competitiveness.

Methodology

The methodology involves using the scenarios to estimate the likely effects of changes in the fare structure, taking the current fare mechanism as a baseline.
Analysis involved the following stages:
- Calculate the changes in fares for each scenario
- Estimate the change in cost for existing users resulting from each scenario.
- Estimate the price and frequency elasticities of demand (i.e. the % change in demand resulting from the % change in price or frequency) for each user group and calculate the change in traffic that would result from altering the current mechanism
- Separate the change in traffic into each main user group – local residents and visitors
- Estimate the resulting change in expenditure for each user group
- Estimate resulting changes in annual output and employment in the Western Isles by applying appropriate multipliers to changes in expenditure
- Estimate the impact on business efficiency, i.e. change in exports

Changes in Fares Only

Changes in fares under each scenario were estimated by applying the appropriate formula to current fares.
For RET, this involved the formula:
$C = L \cdot O \cdot D + T$
As described above.
The TTT fare mechanism is a distance-related tariff constructed by inserting a “taper” in the scale such that above a selected distance the rate per kilometer of passage distance is reduced.
On a graph the “taper” is represented by a kink.
The effect of this “kink” is to lower the charges for long routes to below those that would obtain on a “pure” distance-related tariff.
The Reduced TTT is calculated in exactly the same way, only fares are adjusted to give an initial approximate match to current charges, revenue and subsidy levels, resulting in an approximate 30% reduction in fares.

Alternative Operating Scenarios

The above scenarios represent the effects of applying a variety of fares mechanisms to the Western Isles ferries as currently operated.
It is not, however, possible to achieve a significant reduction in fares unless one of two things happens, i.e. subsidy is increased or operating costs per unit are reduced.
The level of subsidy is already high and we have assumed that a major increase would be difficult to justify.
We therefore consider whether alternative operating styles can reduce unit costs, and therefore, reduce fares overall without a large increase in subsidy and whether it is possible at the same time to improve services.
The changes made to ferry services under the alternative operating conditions are:
- Shortening the Stornoway Route
- Providing a dedicated vessel for each of the Uig routes
- Introduction of a Lochboisdale-Mallaig route, combined with downgrading of the Oban-Castlebay- Lochboisdale route
- Extending the operating hours of the inter-island routes.

Impact on Existing users

The savings made by existing users will have a positive impact on the Western Isles economy, as a proportion of money saved on ferry fares will be spent elsewhere within the Isles.
Savings by existing users have been estimated by calculating the change in fare under each scenario, and scaling this up to current (2003) traffic levels.
In calculating savings, we have assumed no multi-journey discounts.
Based on the 2003 traffic figures for the Western Isles, it is assumed that across all routes, existing users consist of 61% tourists and business visitors and 39% local residents and businesses.
This distinction between local residents and visitors is important in calculating the economic impact of ferry fare changes, primarily because only a small proportion of fare revenue saved by visitors will be actually spent in the Western Isles, whereas a much larger proportion of fare savings by residents will be spent there.
For the purposes of this study, we have assumed 5% of savings by existing visitors and 100% of savings by existing residents would be spent in the local economy.

New Traffic - Price and Frequency Elasticity

A reduction in ferry prices under any of the scenarios will also result in new users and therefore new ferry traffic.
New users will be either local residents or visitors.
To estimate the overall increase in traffic, the price elasticity has been calculated.
Price elasticity measures the responsiveness of ferry traffic demand to a change in fare.
The higher the value the more responsive traffic will be to a change in price.
We selected values for car and passenger traffic from the Scottish Office Industry Department (SOID, 1992) study on fare price elasticities.
This is the most comprehensive elasticity study conducted to date and has the advantage of estimating values specifically for Western Isles routes.
The value for CV price elasticity was taken from the SOID (1993) study on the evaluation of impact of ferry subsidies.
Price is, however, not the only stimulant of traffic.
Increased frequency, improved passage time and extended operating hours can also reduce the barrier to travel or “impedance” which a ferry crossing presents.
While there is strong empirical evidence that traffic will increase with improved frequency, regularity and hours of operation, we are not aware of any systematic analysis previously undertaken of the actual elasticity of these “impedance” factors.
We have, however, been able to estimate a “frequency elasticity of demand” (FED) by examining data on a number of comparable routes, e.g. islands with similar populations but with dissimilar fares and frequencies.
These ‘comparator’ routes were similar in length and destinations served, to those in the Western Isles, but with a higher service frequency.
In most cases the comparator routes were also cheaper, but in one case (Kennacraig – Islay/Jura) the route was more frequent and more expensive.
On these routes, we estimated the likely difference in traffic that could be accounted for by the lower/higher fare, using the above elasticities.
Any residual change in traffic after taking this into account was then assumed to be due to higher frequency on the comparator route.
On this basis we were able to work out a frequency elasticity of demand (i.e. the responsiveness of ferry traffic to a change in service frequency) for each of the comparator routes and apply this value to the Western Isles routes to estimate the likely change in traffic on each route resulting from application of our alternative mechanisms to these changed operating patterns.
The frequency elasticity of demand was calculated to be 0.1 for Oban/Castlebay/Lochboisdale and 1.04 for all other routes.
Frequency elasticity was only applied to passengers and cars to reflect the source data.
The practical effect of this FED is that doubling route frequency (i.e. number of single journeys per day) would have a similar effect as halving fares on an existing frequency.
If at the same time both fares were halved and frequency doubled the two elasticities require to be multiplied, resulting significantly greater traffic growth than if only one elasticity applied.

New Traffic - Local Residents Versus Visitors

In terms of pure expenditure, an increase in ferry use by local residents will remove money from the economy, due to both increased spending on ferry fares and on goods and services purchased while outside the Western Isles.
In contrast, an increase in visitor traffic will lead to increased local expenditure.
We have estimated the amount of new local resident traffic by applying the estimated percentage of current local resident traffic to the overall increase in ferry users.
New visitor traffic has been estimated by applying the estimated percentage of current visitor traffic to the overall increase.
To do this, we have made the following assumptions:
- The proportion of visitor traffic is the difference between summer and winter foot passenger, cars and coach traffic on each route.
- Traffic will increase in the same proportion to existing traffic, third, the remaining increase in car and passenger traffic will be local residents, fourth, CV traffic is 50% local and 50% non local all year round

Estimating the Change in Expenditure for New Traffic

The estimated expenditure of the new visiting ferry users has been calculated using figures from the Western Isles Visitor Survey (MacPherson Research,1999), which gives average spend per person per trip in the Western Isles as £203.
This includes visitors on holiday, visiting friends and relatives (VFR) and business visitors.
This figure has been used to calculate expenditure for all users, except non-resident CV drivers, where we have calculated an average spend of £47, as this group of users will stay for shorter periods.
This was multiplied by the estimated number of new visitors on routes to/from the mainland.
The estimated expenditure of new local ferry users, which will have a negative impact by removing money from the local economy, has been estimated by multiplying the traffic increase for passengers and for each vehicle type by the relevant fare for this.

Calculation of Changes in Output and Employment

The detailed process used to calculate the impact can be summarized as follows:
- The change in expenditure for existing and new users
- From this the amount entering the Western Isles economy was estimated
- Appropriate multipliers were applied to give gross output change
- The gross output change resulting from increased business efficiency was estimated (see below)
- Appropriate employment multipliers were applied to gross output to calculate the change in employment.

Expenditure Entering the Western Isles Economy

Only a proportion of money spent by local residents and visitors will remain in the Western Isles economy.
Much of this will be spent on imported goods and services and taxation.
It is only this remaining expenditure that will be retained in the economy and be subject to multiplier effects.
Drawing on existing data for the Western Isles, we have made the following assumptions regarding expenditure:
- 48% of resident expenditure will remain in the local economy
- 71% of visitor expenditure will remain in the local economy

Gross Output Change from Additional Expenditure

Gross output measures the change in output of local businesses resulting from changes in ferry fares and services.
Essentially, it measures the size of the Western Isles economy.
This can be due to increased expenditure by locals or visitors, or increased profits earned by businesses as a result of increased competitiveness driven by lower import/export costs and more reliable connections.
In calculating the gross output change resulting from increased expenditure, it was assumed that the multiplier for local resident spending is 1 and the multiplier for visitor spending is 1.49.

Gross Output Change from Business Competitiveness

In addition to extra spending by local residents and visitors, there will be increased competitiveness among Western Isles based businesses due to lower import prices and/or reduced cost of exporting goods and more frequent and reliable connections with markets and suppliers.
The resulting increased business activity among export sector businesses will lead to increased output and employment in these sectors.
There may also be a potential increase in the number of firms, although this is likely to be relatively small and is excluded from further analysis.
In summary, the increase in output was calculated in the following way.
- Six key exporting industries were selected: Agriculture; Sea fishing; Fish farming; Textiles; Fish processing, wholesaling etc.; and Other manufacturing.
- The baseline output in the Western Isles for each of the above sectors was taken.
- Estimates for ferry price final demand (FPFD) multipliers were then calculated using estimates from SOID (1993) – these measure the responsiveness of industrial output to a change in ferry fares.
- The FPFD (F) was then multiplied by the weighted average ferry fare change in each scenario (ΔP) to calculate the percentage change in output for each sector.
- This was applied to total current output (Yt-1) to reveal estimated likely change in output for each of the key exporting sectors for each scenario.
  $
- This can be summarized by the following equation:
  $\Delta Y<em>t = F \Delta P Y</em>{t-1}$

Employment Change

To calculate the resulting changes in employment, employment coefficients from the 1997 Western Isles Regional Accounts (CnES, 1999) were applied.
These show the number of FTE jobs required for each £1000 of output.
The employment coefficients used were 0.03 for output resulting from domestic expenditure, and 0.04 for output resulting from changes in visitor expenditure, to reflect the balance of sectors likely to be stimulated – visitors tend to spend a higher proportion in sectors with higher employment coefficients.
To calculate the overall change in employment, the employment coefficients were multiplied by the total gross change in output from extra expenditure and business competitiveness.

Results: Overall Economic Impact

A summary of the estimated expenditure and resulting impact under each scenario.
This shows the estimated additional expenditure entering the Western Isles economy and the resulting increases in output and employment under each scenario.

Conclusions

Using the methods detailed above, it has been possible to calculate the impact of a number of widely differing fare and operating mechanisms on the economy of the Western Isles.
Taking current operating mechanisms (routes, schedules, vessels) we examined a wide of options and permutations.
Under RET all fares would be reduced, mostly very substantially, traffic would also increase substantially requiring capacity increase and subsidy would be increased significantly.
Under a distance related (length based) (revenue/subsidy neutral) tariff CVs would be cheap, but passengers and cars would be expensive on long routes, therefore a Tailored Tapered Tariff (TTT) can be adjusted to match subsidy available and is fairer on long routes.
If revenue neutrality were relaxed, a Reduced TTT would reduce fares and increased traffic but with some increased subsidy requirement.
Under present operating conditions, however, the scope for reducing fares is limited unless subsidy is increased.
In view of the last above comment, we explored an illustrative alternative operating scenario featuring the TTT fares mechanism combined with shorter routes, new capital investment, different vessel types, utilization and operating practices.
Calculation of a frequency elasticity of demand has allowed the estimation of the effects on increased service frequency on traffic generation, and hence expenditure and output.
This alternative scenario leads to beneficial effects on fares and traffic generation, with many fares and charges reduced, very significant traffic growth stimulated, increased revenue is generated.
Overall subsidy requirements are reduced under TTT, including annualized costs of new capital investment, and with TTT reduced by approximately 30%, traffic would increase further but with some increase in subsidy.
Such a radical improvement in ferry services would bring significant economic benefits to the Western Isles.
In conclusion, therefore, the methodology used has allowed us to more accurately estimate the true impact of a radical change in operating conditions, to allow direct comparison with a simple change in fares.
Future research will extend this methodology to examine the impact of changes in frequency on business competitiveness and to quantify the effect of timetabling and other ‘softer’ changes in service quality, such as customer service, harbor facilities and vessel comfort.