Examination of Witnesses (Questions 140-159)
DEPARTMENT FOR
TRANSPORT, STRATEGIC
RAIL AUTHORITY
AND NETWORK
RAIL
26 MAY 2004
Q140 Mr Williams: Mr Armitt, you joined
Railtrack in December 2001 and you came with a distinguished record
with established private sector companies: Chairman of John Laing
plc followed by Chief Executive of Costain and you were Chairman
of Union Railways. So, considerable business experience. If we
look at pages 8 and 9—and you do not need to look, I will
read it out—under the main subheadings, it says that, "The
Department identified Railtrack's major shortcomings" as
"Under-investment in the infrastructure", "Poor
value for money management . . .", "Loss of engineering
skills and asset knowledge" and "Poor industry relationships
and general lack of leadership." How long did it take you
to realise that you had inherited an absolute shambles?
Mr Armitt: Given that I was appointed
by the administrators three or four months after Railtrack was
put into administration, I went into the job realising that probably,
yes . . . Clearly, things—
Q141 Mr Williams: Did you realise the
scale of it? How long did it take you to realise the scale of
it or would you say that you went in fully aware of the situation?
Mr Armitt: I certainly did not
go into it fully aware of the degree to which there had been under-investment
and the degree to which there was a need for significant increase
in the investment and state of the infrastructure, and clearly
that and the lack of Railtrack's ability to fund that and minimise
the degree to which it was going to have to fund itself going
forward, of course—
Q142 Mr Williams: So, once you got in
there, these were not minor shocks, they were quite considerable
shocks.
Mr Armitt: Yes and no. Having
taken interest in the railways in the past, one was aware that
British Rail itself, before Railtrack, had gone through some difficult
times for a very long time and therefore the industry and the
infrastructure of the railways was one—
Q143 Mr Williams: At paragraph 1.18,
it makes the point, "Railtrack's knowledge of the condition
of its assets had deteriorated since privatisation so it did not
know what needed to be done to put problems right, how much it
would cost, or what the risks were." Were you aware of that
when you went in or was that something you discovered yourself?
Mr Armitt: Certainly that was
something which one grew to understand and, as you looked inside
the company and understanding the company, it was a direct consequence
of the decision that privatisation and the need to outsource totally
the maintenance activities and with that went an enormous amount
of information away from Railtrack, Railtrack having decided fundamentally
that it wanted to be the owner of an asset which it employed others
to look after.
Q144 Mr Williams: Was the seriousness
of this lack of information about the condition of its assets
immediately apparent or was it something that you discovered subsequently?
Mr Armitt: That had been understood
before I arrived and work was in place to actually put in programmes
and the Regulator had understood that.
Q145 Mr Williams: What I do not understand
is that, in paragraph 1.21, it says that the Department carried
out in June 2002, that is seven months after you were appointed,
an evaluation of the bid and it says that, in carrying out this
evaluation, "As the realities of the situation (such as the
poor quality of data on asset condition) become clear, the Department
realised that the depth of the analysis that Network Rail could
carry out, and therefore the detail of the plans it put together,
was limited", but they did not seem to be aware of that or
become aware of it, according to the wording here, until they
were in the process—and I do not know whether you were there,
Mr Rowlands, at this stage. I do not know whether they were aware
of this in advance because, reading this, it seemed that a sort
of sadness dawned on the Department as it was trying to evaluate
the bid. Which is correct: Mr Armitt saying he felt it was implicit
in the situation or, as stated here, it came as a surprise to
the Department?
Mr Rowlands: Can I try to help?
I do not think there is a tension between those two points. What
became clear with Railtrack in administration was the administrator's
growing inability to put together the data room you would have
needed to invite bids from the outside world because, the more
he got into it, the more they discovered that the information
was not there in terms of the asset base and so on. From Mr Armitt's
perspective, what he is saying is that clearly there were serious
problems with this company four months after it went into administration
and, in that sense, he knew there were difficulties.
Q146 Mr Williams: In that case, Mr Armitt,
if you felt it was rather complicit in the situation, had you
done anything to try and put it right between then and the time
the Department had to carry out this evaluation in June?
Mr Armitt: Two things were going
on at the same time. There was in place an exercise—and
it is continuing today—to improve and build up the knowledge
of the asset base. That was going on at the time I arrived. The
Regulator had in fact required Railtrack to put in place action
to improve knowledge of the asset condition. In a bid situation
such as you have after this organising, the ability of the administrator
to lay his hands on sufficient quantity of information to enable
Network Rail to put their bid together was limited.
Q147 Mr Williams: It needed to be much
more precise?
Mr Armitt: Yes.
Q148 Mr Williams: If you look at paragraph
2.31, we come to this question of incentives and it says that,
"Inappropriate commercial incentives played a large part
in Railtrack's problems, so having the correct incentives for
Network Rail to perform well is extremely important"—that
is a strong statement in National Audit Office terms. "Network
Rail's own incentive schemes have a direct effect on managers'
bonuses and are therefore of key importance." This is interesting.
This incentive system was seen as absolutely central. It goes
on—and I promise you it will be shorter dealing with it
in this way—in paragraphs 2.34 and 2.35, we find that the
NAO looked at Welsh Water which was a non-profit company, they
looked at the oil industry, the air traffic industry and Deutsche
Bahn, the German railway company, and they all came up with a
form of incentivisation which you or the Department seem to have
rejected. Why is that?
Mr Armitt: I do not think we have.
The fundamental point of view is, do we have an incentive for
financial efficiency, and we undoubtedly do have. A key part of
our efficiency regime has been financial efficiency. It is called
the FEI, it is there to measure the efficiency with which we spend
money and the efficiency with which we carry out our duties.
Q149 Mr Williams: I do not quite read
it that way because, if you go on to paragraph 2.36, again you
have to watch the wording very carefully because the NAO is very
cautious about its wording and that is often what much of the
arguing takes place over when they are agreeing the Report with
the Department. To follow on from those examples, "the circumstances
of other businesses will differ" and then it says, "the
Department, SRA and Network Rail see some attractions to such
a measure they consider it is not possible to develop a meaningful
one in Network Rail's context." Can we come to the Audit
Office. Usually, with the Audit Office, we do not differentiate
with the base audit with the National Audit Office. It is not
just a statement that there was not a possibility to do that,
it just says that they considered. Does that mean that you disagree
with their summation?
Mr Colman: We thought this was
an idea worth considering and that suggestion is their view.
Ms Leahy: I think we thought that
for any measure to be really effective, the company would have
to own it and feel that it was worth having. So, we noted really
that other industries had such measures and found them valuable.
We thought there were attractions but we put it in the way that
we did because, if the company did not actually agree, then we
felt it probably would not be useful.
Q150 Mr Williams: You then go on to criticise
them having made the incentive system the centre of the recovery
programme probably, you then go on in paragraph 2.37 to throw
doubts on the long-term element, which is essential, in the plan
which they did accept. Was this a subject of much dissertation
between you or was this section agreed relatively easily?
Ms Leahy: It was certainly discussed
quite extensively, so I think we probably understood the company's
view on this. My own view, if I am allowed to comment on this,
is that it is the sort of concept that might take some working
up and that they might well work through after this and decide
that there was something like this that would be worthwhile.
Q151 Mr Williams: It is more than a slight
disagreement. There is a fundamental difference of approach here
because they take themselves into a rolling three-year programme
about which you have considerable doubt. You say, "Over a
normal three year period insufficient spending on maintenance
work may save money and lead to increased rewards under the plan,
but years later translate into increased delays." So, it
is not a matter of you just introducing something temporary, they
are introducing something medium term and now seem to have turned
their back. There is no work being done I assume in the organisation,
Mr Armitt, in relation to draw on the experience of these other
industries to see how far they could be relevant to you.
Mr Armitt: We are more than willing
to do that.
Q152 Mr Williams: You may be more than
willing but have you done it or are you doing it?
Mr Armitt: We are in the very
early stages of this incentive plan and the criteria which are
used at the moment, which is asset condition, financial efficiency
and performance, the objective of having those three is that you
cannot actually play one off against the other without failing
on the other. So, a single overriding measure such as Deutsche
Bahn has in cost per passenger kilometre carried. Clearly, if
the number of passengers goes up, then your cost per passenger
carry has gone down without us doing anything at all. So, it does
not necessarily drive us to extra efficiency. We are more than
willing to review these incentives because it is in our interests
to ensure that we have ones which work and we have these three
which we believe are operating at a more detailed level within
the company and bringing more focus on efficiency. The Deutsche
Bahn one is a very overriding high level one which we believe
could be of benefit over a five to ten year range but would not
be of benefit to us today. We think that what we have in place
today gives us the best opportunity to get the right balance in
improving efficiency whilst keeping the condition of the asset
also in an improving situation, but we are more than willing to
listen to other ideas and I am sure that the Remuneration Committee
and the ORR who have an overriding view of this will do so.
Q153 Mr Williams: In the following paragraph,
it says, "In addition to its own Management Incentive Plan,
Network Rail is incentivised by regulatory performance targets
and regimes . . . " Are these regulatory schemes compatible
with the system you have adopted or do they work in parallel with
it or do you see them in any way conflicting?
Mr Armitt: They work in parallel
with it. For example, one of the benefits of reducing the number
of broken rails is that we actually improve the asset condition
and the asset register and, in terms of the Regulator's approach,
he allows us more money to go into the railway when we have reduced
the number of broken rails.
Q154 Mr Williams: Coming back to Mr Steinberg's
point on incentives, I notice that if you have your full 60%,
you will take a modest £0.75 million. Does the 60% apply
only to the salary section or does it apply to the fringe benefits
as well?
Mr Armitt: It applies to the basic
salary.
Q155 Mr Williams: So, you got a low quality
deal.
Mr Armitt: I would not say that.
Chairman: There are one or two supplementary
questions.
Q156 Mr Jenkins: I cannot miss the opportunity
to ask Mr Bowker something which has always bothered me. You pay
the train operators an amount of money, a subsidy of £1,700
million in 2002-03 and then they paid £1,000 million of that
for access charges. Why do we bother with this? Why do we not
just bother to pay the money to Network Rail, say £1,000
million worth, and then they reduce their access charges by 60%
and therefore encourage maybe more providers into the system?
Mr Bowker: I do not believe that
that of itself would encourage more providers into the system
but the relationship between access charges or grants is one we
keep under constant review. We have paid quite a lot this year
by way of direct grant as opposed to access charges. The advantage
of the access charge regime is that it actually incentivises a
proper commercial and performance-driven relationship between
Network Rail and the train operators.
Mr Jenkins: It always seems strange that
you are handing out subsidies and handing them back to the people
rather than . . . If it really was an incentive, there really
was a marketplace, we would not be handing out £1,000 million
a year for subsidy.
Q157 Mr Bacon: Mr McAllister, I read
in the Report that you have net debt of around £12.8 billion
and it is expected to rise to around £17 billion in this
coming financial year; is that right?
Mr McAllister: Yes.
Q158 Mr Bacon: On page 30 of the Report,
the chart talks about Network Rail's acquisition and initial finance
arrangements. It does not cover all of those figures, I do not
think. Certainly in terms of what is drawn down, there is no way
that you get to £12.8 billion. In fact, it comes to £9.19
billion. Do you see the second column, "Amount drawn down
as at 31 March 2003" and admittedly that is a little out
of date now but is it simply that, since then, there has been
another roughly £3.8 billion drawn down?
Mr McAllister: Yes.
Q159 Mr Bacon: Mr Armitt or Mr Rowlands,
could we have an up-to-date chart sent to us to include in the
report showing all the borrowings, the gross borrowings and the
net borrowings and, in every respect, the exposure of Network
Rail and of the SRA and of the Department and of the Treasury?
Mr Rowlands: Yes.[1]
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