Model or muddle?
9. The Government cites the growth in rail patronage
as a partial indicator of the success of the post-privatisation
rail system in achieving the objectives set for it.[17]
Several of our witnesses were sceptical about passenger growth
being used as an indication of system performance. The Railway
Consultancy said that it would be invalid to claim that there
is a "simple correlation between rail industry structure
or franchise type with traffic growth."[18]
John Segal of the MVA Consultancy told the Committee that "one
of the key reasons demand increased was that fares were held down.
Had fares been held down under British Rail then some of the demand
growth would have happened without [franchising]."[19]
Mr Ford added that the decline in patronage in the early 1990s,
before privatisation, had been the result largely of macro-economic
factors, such as recession and high unemployment.[20]
10. Professor Knowles evaluated the delivery of the
original objectives of rail franchising from the time of privatisation,
and concluded that the franchise model had failed to fulfil them.
He too saw passenger growth as only partly the result of privatisation
and, identifying the central contradictions behind the franchising
model, questioned the basic rationale for rail passenger franchising:
"Is it realistic to expect competition for
franchises in a basically loss-making industry to lever in substantial
private sector investment and deliver extensive consumer benefits?
Rail privatization will struggle to meet its investment, passenger-growth,
and subsidy-reduction targets in a regime with extensive regulation
of fares and little 'on track' competition permitted. Rail passenger
services also face intensive intermodal competition with cars,
air services, and intercity coaches."[21]
One independent passenger organisation, the Railfuture
Passenger Committee summed it all up: "we are frankly not
convinced that franchising is the only - or indeed the best -
way of running the passenger railway."[22]
11. We agree wholeheartedly with the general objectives
of improving passenger services and maximising the value for money
achieved from Government subsidies. But we do not believe that
the current system of passenger rail franchising can achieve those
aims in the long term.
12. Our inquiry exposed fundamental tensions at the
very heart of the Government's model. The Government has embraced
the notion that private enterprise is best at delivering high-quality,
innovative services such as the passenger railways, and yet it
does not trust companies to deliver these services without highly
detailed and specific contractual requirements which reduce the
scope for innovation. It supports competition, and yet appears
to see open access operators as a threat to stability. It wants
risk to be transferred from the public to the private sector,
and yet risk cannot be transferred in anything other than name
because, as everyone knows, no Government could afford to let
the railways go bust. The Government hails the growth in passenger
patronage, and yet it does not provide the long-term strategy
and investment to increase capacity on the network. It wants coordination
and yet continues to operate a system of fragmentation. Finally,
the Government wants the private sector to invest, take risks
and innovate, and yet it prioritises price above all of these.
There is scant evidence that the current model balances and optimises
the benefits from conflicting priorities. It looks more like a
muddle that provides little more than a complex, costly and mediocre
means of maintaining the status quo.
13. The Government has announced its intention to
publish a long-term vision for the railways in the summer of 2007.
This initiative is welcome, though long overdue.[23]
The strategy will look at long-term infrastructure requirements
in the rail industry, but to have any real value, it should also
contain a root and branch review of the way in which services
are provided to passengers. The long-term strategy is an opportunity
for the Government to provide real vision and direction for the
development of the railways, backed by investment. This opportunity
should not be missed through a failure to address the most fundamental
questions of structure and long-term direction. The Government's
long-term vision for passenger rail services should be set out
as an integrated part of its vision for the railways. This vision
should in turn, be fully integrated into an overarching long-term
transport strategy.
14. It is clear that after more than a decade of
upheaval and flux, the railways need stability and continuity
to consolidate and take stock. It might be argued that this is
not the right moment to commence a major reorganisation of the
way in which passenger rail services are being procured and managed.
However, the fact that the Government constantly has to tinker
with the system in order to overcome the consequences of fundamental
system failures, means that such stability is not likely to emerge
without further fundamental change.
15. The objectives of the passenger rail franchising
system are a self-contradictory muddle, providing no coherent
framework or vision for the development of passenger services
for future generations. The result is a system that is worth less,
and costs more, than the sum of its parts. It is high time that
the Government established a consistent and achievable set of
objectives and a system capable of achieving them whilst providing
good services and value for money to passengers and taxpayers.
16. The key objective of our railways for the
next few decades must be to increase capacity, and facilitate
growth in patronage through improvements in services to passengers.
The only way to achieve this in the long term is to drop the dogmatic
pursuit of competition where competition is not possible, and
to make honest and tough choices about what the private and public
sectors can and should do in future. We expect the Government's
forthcoming long-term strategy for the railways to tackle these
fundamental issues head on. It must contain a structure and a
strategy capable of securing quality passenger rail services to
meet demand over the next half a century.
Risk
17. The transfer of risk from the public to the private
sector is a key objective in the privatisation of public services.
However, a number of witnesses argued that with regard to passenger
rail services, the transfer of risk to the private sector has
been quite limited.[24]
The reason for the lack of risk transfer is primarily because,
at the end of the day, no Government can afford to let part of
the railway system collapse. As a result, the Government and the
taxpayer pay for a large part of the risk in the system. Mr Segal
of the MVA consultancy told the Committee that:
"Some risk is borne by the operators but
it is a relatively small amount. They have £10 million to
£20 million invested in this. If it is making £400 million
turnover, that is a hugely small investment and they can walk
away from it if necessary. They lose some credibility but they
can walk away. The government would have to make sure the train
services run and it can refranchise and relet it. The big risk
is, if there is a downturn in the economy, almost all the train
operating companies will find great difficulty on their revenue
line and that means the government will end up bailing it out.
As the saying goes, if you owe the bank five pounds you are in
trouble; if you owe the bank five million, the bank is in trouble.
In this case, the government is in trouble because if it has to
relet all the franchises at once it is going to get lower bids
for them. That is an unavoidable risk. The economy is the government's
risk."[25]
18. Examples of areas where risk is not transferred
to the private sector, as one might have expected, are track access
charges and the cost of industrial action. In the case of track
access charges, the Government insulates franchises against increases
in Network Rail's fees for accessing the track by adjusting premiums
or subsidies to take account of any changes in access charges.[26]
Another example is the cost of industrial action where the Government
compensates franchise operators for losses incurred. The SRA paid
out £15.65 million in 2003 and £7.63 million in 2004.[27]
One operator alone, National Express Group, was paid £12.65
million in respect of disputes on its ScotRail franchise.[28]
19. The transfer of risk to the private sector is
also highly inconsistent. Given the high level of risks borne
by the Government in areas such as track access charges and industrial
action, it appears strange that franchising companies are left
to bear the risk of open access operators affecting their revenue
without any assistance from the Government.[29]
This issue is discussed at length in Chapter 6 below.
20. Changes to franchise contracts in recent years
have served to reduce the risk exposure of TOCs still further.[30]
These changes are an attempt to minimise the risk for the Government
of operators getting into financial difficulties and seeking to
re-negotiate the terms of their contracts part-way through the
franchise.[31] Franchise
contracts now generally include "revenue risk-sharing mechanisms",
also known as "cap and collar protection". This typically
means that after the first four years of the franchise contract
have passed:
i. "50 per cent of any fares revenues in
excess of 102 per cent of the TOC's original forecast are shared
with DfT;
ii. DfT makes a contribution equivalent to 50
per cent of any revenue shortfall below 98 per cent of the TOC's
original forecast;
iii. but for any shortfall below 96 per cent,
DfT's contribution increases to 80 per cent."[32]
21. In the past, a significant number of franchise
contracts have been re-negotiated part-way through their term
because franchise operators have found themselves in financial
difficulties.[33] Since
taking back the responsibility for franchises from the defunct
SRA, and implementing the new arrangements outlined above, the
Government has been adamant that it will no longer re-negotiate
contracts under any circumstances, and that it is prepared to
see an operator go to the wall rather than renegotiating contractual
terms.[34] This resolve
remains to be seriously tested. But with some operators entering
into very high premium contracts on the basis of very optimistic
growth forecasts, it is likely to be a question of time only before
the Government has to show its mettle. GNER has already admitted
that the growth projections upon which it agreed to pay £1.3
billion for the East Coast Main Line franchise just 18 months
ago were unrealistic.[35]
On 22 October 2006, The Sunday Times reported the Chief
Executive of Seacontainers, GNER's parent company, to have said
that GNER would have to hand its franchise back to the Government
by May next year if the terms of the franchise were not renegotiated.[36]
22. The Government already appears to be shifting
its position and opening the door to renegotiations, despite its
firm commitment to the contrary when giving evidence in July.
Mr Lambirth, the Director of Rail Strategy & Finance at the
DfT assured us in oral evidence that, in the case of the newer
types of franchise contracts with revenue-risk-sharing mechanisms
built in, the Department would be 'sticking to the letter of the
contract,' and not renegotiating.[37]
When asked to confirm this commitment in October, the Secretary
of State wrote to us that 'more generally [
] we are not
prepared to renegotiate the main terms on which a franchise was
awarded in the first place other than in circumstances where doing
so would clearly benefit the public purse.'[38]
The emphasis on optimising the benefit to the public purse is
new, and appears to open up the possibility of renegotiating contracts
where it would be cheaper to do so than to refranchise. This change
of emphasis has undoubtedly come about because the Government
may soon face the choice of either renegotiating a contract, or
seeing a major franchise, awarded just eighteen months ago, being
handed back. The implications of such a change would be significant
and damaging. Operators would be able to produce over-optimistic
revenue forecasts and bid wild sums to run franchises, safe in
the knowledge that the Government would bear the full risk of
any failure to meet the forecast revenue figures.
23. The practice of renegotiating contracts effectively
meant that the Government was underwriting franchise operators
in the past. This is the ultimate form of risk retention by the
Government. Having re-designed franchise contracts to include
'revenue risk-sharing mechanisms', it is crucial that the Government
resist any pressures to renegotiate franchise agreements if operators
get into difficulties. If it were to bail out operators through
renegotiation despite taking over most of the medium- and long-term
revenue risks, the Government would have failed doubly.
24. The risk to the Government is potentially compounded
by the fact that the concentration of the market means that a
few large companies increasingly run multiple franchises.[39]
If the Department for Transport were to use the cross-default
principle, as has been hinted, whereby a franchise operator that
runs multiple franchises will lose all its franchises where it
fails to fulfil its obligations in one of these, the Department
could be left with a very large financial and management problem.[40]
The concentration in the market also means that, in such situations,
it might be difficult for the Government to find bidders able
and willing to take on a whole series of franchises removed from
a failing incumbent at an acceptable price.
25. The transfer of risk to the private sector
was a core objective of privatisation. But in the current system
only a very limited proportion of risks are, in reality, borne
by franchise operators. There are also significant inconsistencies
about what risks are borne by operators, and which by the Government.
The relative lack of risk transfer calls into question the fundamental
assumptions and objectives of the franchising system. If risk
is not transferred, there is little point in involving the private
sector in the running of the railways.
6 Pryke, R.W.S and Dodgson, J.S. The Rail Problem
(London, 1975); See also Bonavia, M.R. British Rail: The First
25 Years (Newton Abbot, 1981); Gourvish, T. British Railways:
A Business History (Cambridge,1986) Back
7
See Ev 222 [Professor Richard Knowles]; Richard D. Knowles: "Impacts
of privatising Britain's rail passenger services - franchising,
refranchising, and Ten Year Transport Plan targets", Environment
and Planning, volume 36, 2004;Stephen Glaister, "British
Rail Privatisation - Competition destroyed by Politics" Centre
for the Study of Regulated Industries, Occasional Paper 23,
November 2004, p 7ff. and p 17 ff Back
8
Department for Transport, The Future of Rail, White Paper,
Cm 6233, July 2004 Back
9
Q 408 [The Parliamentary Under Secretary of State, Derek Twigg
MP] Back
10
Ev 142 [Department for Transport] Back
11
Ev 208 [Simon Norton]; Ev 39 [Railfuture]; Q 326 [Mr Ford] Back
12
Ev 59 [Merseytravel] Back
13
Ev 212 [Tony Bolden & Reg Harman] Back
14
Q 167 [Dr Nigel Harris, The Railway Consultancy] Back
15
Q 293 [Mr Ford] Back
16
Ev 7 [GNER] Back
17
Ev 142 [Department for Transport] Back
18
Ev 93 [Railway Consultancy] Back
19
Q 168 [Mr Segal, MVA] Back
20
Q 273 [Mr Ford] Back
21
Richard D. Knowles: Impacts of privatising Britain's rail passenger
services - franchising, refranchising, and Ten Year Transport
Plan targets published in Environment and Planning, volume 36,
2004 Back
22
Ev 39 [Railfuture] Back
23
This strategy is due to coincide with the High Level Output Statement
(HLOS) which sets out a five-year purchasing strategy for the
network. Back
24
Ev 93 [The Railway Consultancy] Back
25
Q 203 [Mr Segal, MVA] Back
26
NERA Economic Consulting: Implications of Amending Franchise
Agreements Final Report for ORR, July 2006, pp 4-7. Available
at http://www.rail-reg.gov.uk Back
27
HC Deb, 24 November 2005, col 2226W Back
28
HC Deb, 15 May 2003, col 340W Back
29
See HC Deb, 18 May 2006, col 1129W Back
30
NERA Economic Consulting: Implications of Amending Franchise
Agreements Final Report for ORR, July 2006, p 2. Available
at http://www.rail-reg.gov.uk Back
31
Such renegotiations have occurred on a number of occasions in
recent years, sometimes resulting in TOCs "operating for
extended periods under 'cost plus' contracts" See Ibid.
Back
32
Ibid. p 3 Back
33
More than half of the original 25 franchises created at privatisation
agreed changes to their contracts in the course of the contract. Back
34
Q 489 [Mr Lambirth, Department for Transport]; See also Q 28 [Mr
Furze-Waddock, First Group; Mr Smith, Govia]; Qq 35-38 [Mr Smith,
Govia; Mr Lyons, Railway Forum; Mr Franks, National Express] Back
35
The Independent, 17 October 2006, p 36; see also The
Guardian 17 October, p 26. When awarding the franchise to
GNER in March 2005, the SRA hailed it as "the biggest deal
in European rail history". See SRA press release, 22 March
2005, available at http://www.sra.gov.uk Back
36
Sunday Times, 22 October 2006 Back
37
Qq 406-407 [Mr Lambirth, DfT] Back
38
Ev 206 [Department for Transport] Back
39
See paras 71 and 72 above Back
40
Modern Railways, July 2006, page 3 Back