Optimal quality incentive scheme design in contracting out public bus services

Designing appropriate quality incentives in contracting out public bus services is essential to ensure that cost savings are not pursued at the expense of deteriorating quality. This study investigates a practical incentive design problem that links additional rewards and penalties to quality indicators of bus services. A leader–follower game model is proposed in which the transit authority (leader) determines the quality baseline of each bus service as well as the marginal reward for outperformance and penalty for underperformance. Subject to a given amount of budget, the transit authority has to guarantee a minimum profit margin for each transit operator so that they have enough incentives to improve the service quality. As a response, the profit-maximizing transit operators (followers) determine the level of service quality by weighing the marginal revenue and cost involved. A tailored solution approach is devised by exploiting the model properties. Motivated by Singapore’s recent trial, a case study is presented to demonstrate how the transit authority can determine the performance baseline as well as the reward-penalty levels for a large bus network and evaluate the amount of public funds needed to achieve a targeted quality outcome. Our analysis also cautions that quality deterioration may surprisingly occur in a few bus services after introducing the incentive scheme. This may be attributed to an unreasonably strict quality baseline and/or an inefficient operator running that service. It is thus suggested that the authority should figure out the real contributing factors and fine-tune the incentive scheme accordingly