Examination of Witnesses (Question 20-39)
MR CHRIS
AUSTIN, MR
PAUL FURZE-WADDOCK,
MR JONATHAN
METCALFE, MR
TOM SMITH,
MR DAVID
FRANKS AND
MR ADRIAN
LYONS
5 JULY 2006
Q20 Mr Martlew: Why do we not have
20 year franchises?
Mr Metcalfe: There is an optimum
balance. We moved to eight to 10 years. There is an argument in
some cases that it could be 12 or maybe 15 years in some circumstances
to leverage in big investments. There is an understandable worry
that 20 years is just too long in terms of the balance and risk.
Q21 Mr Martlew: You are against 20
years?
Mr Metcalfe: I think probably
12 to 15 would be the optimum for a big, heavy investment franchise.
Mr Furze-Waddock: I would be against
20 years unless there were defined review periods as Network Rail
would have. For us to take a 20 year view on such things as revenue
growth is pushing it out an awful long way so the risk increases
as time goes by.
Q22 Chairman: You do not have any
faith in your company still being there in 20 years?
Mr Furze-Waddock: It is more not
having the faith necessarily in the economy for that length of
time.
Mr Austin: To reiterate that point,
having worked previously in the SRA where we did propose 20 year
franchises and indeed secured one in Chiltern which works well,
in general the problem of managing risk over such a long period
means that the optimum period is probably, as my colleagues have
been saying, somewhere between 10 and twelve rather than as long
as 20 but it is certainly longer than the three years you suggested,
Mr Martlew. As you know, coming from a railway town, it takes
a long time to change things in the industry. A lot of these investments
take a long time to come on stream.
Q23 Clive Efford: Is not the answer
to the length of the contracts that you need to be very specific—or
the government needs to be very specific—in what the contracts
must deliver so that the length of the contracts is irrelevant?
Mr Lyons: We come to the nub of
the question. When the government is thinking about letting a
franchise it has to take a very large number of factors into account.
What is the state of the market it is looking at? What is the
state of the condition of the infrastructure and so on? It can
then reach an outcome which suggests what the ideal of franchise
is to let. At that point it can then determine the conditions
that it wishes to see the franchise perform but I think it should
be the outcome of an iterative process that analyses what the
basic business being let is about.
Q24 Mr Leech: I thought Mr Austin
made a very interesting point when he said the industry sometimes
take a long time to get things moving. Do you not think that that
is an argument for shorter franchises to encourage the industry
to change its ways?
Mr Austin: No, I do not, because
a lot of the length of time taken is for very good, structural
reasons. It was no different under BR. Planning and implementing
major projects involving many disciplines and many parties, even
in BR days, took a long time to achieve. New lines can take a
generation, as we have seen.
Q25 Chairman: You are there because
you are not going to be like BR. You have been telling us how
innovative, imaginative and stimulating you are, so you cannot
possibly say you are going to behave like BR because you do not
want to behave like BR.
Mr Austin: There are a number
of structural issues which mean that it takes longer to implement
projects.
Chairman: That will not wash because
that was the whole reason we got a franchise system in, so there
would be different structures.
Q26 Mr Goodwill: It seems that the
present franchising system is certainly good for the government
because they are selling a monopoly on many routes. We know how
much GNER gave for their licence. Would it be possible to come
up with ways of introducing more competition on routes in order
that maybe the pricing of the tickets or the services available
to passengers on trains or at stations could be improved, because
at the moment it does seem that we have this wonderful reward
of franchises and some people would say you then have a licence
to print money during the period of that particular franchise.
Mr Metcalfe: I certainly do not
agree that there is a licence to print money. There is already
intense competition on the east coast main line. There is quite
a significant number of operators up and down the east coast main
line competing against each other, government franchised operators.
We are also competing against the airlines and roads. Competition
is good. It has lifted the game of GNER and other operators to
the passengers' benefit. I think there is a wider question about
the current open access situation but I am not clear whether you
want me to talk more generally about that or not.
Q27 Chairman: If you want to make
general comments on the problem of open access, we would be interested
but they must be very general.
Mr Metcalfe: Competition and open
access per se are good things. Anything that drives new
markets and improves competition is good for passengers and the
industry. What I do not think is good for the industry is a competitive
environment where a new operator can come along and pay different
charges to existing government franchised operators that are then
putting it on a totally different, unlevel playing field and also
gaining the majority of their revenue without carrying extra passengers.
That does not seem to make sense.
Mr Furze-Waddock: The point is
one of understanding the franchise process and how we are committed
within that. We are given a specification and we are asked to
bid against that, to generate revenue and control costs across
that specification. On the back of that for 10 years we commit
to pay the government, through the Department for Transport, very
significant sums of money that we are forecasting, driving up
revenue, getting growth into that network. We have committed to
do that. If you get an open access operator coming along half
way through that process or even earlier in that process, who
is then starting a new service with perhaps not a level playing
field, who is also has a business case based upon extracting a
certain amount of revenue from some of those flows, there is no
flexibility in the franchise agreement to go back to the DfT and
say, "We would like to adjust our service level commitment
because there is now competition so we do not need to run as many
services", and we will have signed up to long term leases
on rolling stock. Our cost base will be very much fixed for the
franchise duration. We have committed to give that revenue to
the government already. If somebody else comes along and says,
"We want to take part of that", it is leaving the public
sector and going into the private sector because we have committed
to pass that revenue on to the DfT.
Q28 Mrs Ellman: What about the issue
of under-bidding for contracts, a bid going in and then being
renegotiated later on? How big an issue is that?
Mr Furze-Waddock: I think the
Secretary of State made it abundantly clear to all train operating
companies and owners that that will not happen in future. There
may arguably have been one or two cases in the past where there
has been renegotiation. The competition is set up in such a way
and the performance bonds are set up so as not to allow that to
happen.
Mr Smith: The department now runs
a very rigorous evaluation process that it has refined and developed
over the years. They will be able to tell you about it in more
detail. We only see it from the other side of the table but the
purpose of that is to ensure that they select realistic bids as
opposed to pie in the sky ones. It goes both ways but it is something
that they are seeking to improve and I believe they are being
quite effective now in the rigour of their assessment.
Q29 Mrs Ellman: Is everybody satisfied
with the information that comes from the department and the way
it is assessed?
Mr Smith: When you win you certainly
are.
Q30 Mrs Ellman: Do you think it is
a fair process?
Mr Metcalfe: The information is
very specific and the franchises that people are asked to bid
against are extremely specific. Possibly there is an opportunity
for them to be slightly less specific to further encourage innovation,
particularly around capacity and around the opportunity to grow
new markets or new services, to try to find ways of creating new
capacity on the network.
Mr Franks: On the `one' rail franchise
that National Express operates, when we were assessed in our bid,
it was against a timetable that had five trains per hour between
Ipswich and London Liverpool Street. The timetable that was successful
delivered six trains per hour throughout the day and enabled more
revenue to be generated. That was an innovative solution to the
timetabling problems that existed on the route but we were judged
in our bid against five trains per hour and that is what every
bidder has to do. If you do highly specify the franchises at bid
stage, it does prevent innovation if you are not careful.
Q31 Mrs Ellman: Has the separation
of franchise contracts into general requirements and franchise
specific items been helpful?
Mr Furze-Waddock: It helps in
the long term because it cuts down on the amount of administration
and negotiation over what are effectively some fairly standard
terms and conditions and boiler plate conditions. It concentrates
the bidder to look at the things that really matter to that specific
franchise.
Mr Smith: I would endorse that
point. It is a way of ensuring that the basic commercial framework
of the contract which the government proposes to enter into with
the operator is well understood at boiler plate level. The specifics
are customised to each franchise. It helps efficiency, market
understanding and the general procurement process.
Q32 Mrs Ellman: To what degree do
you take into account the possibility of open access competition
when you are making your bids?
Mr Furze-Waddock: It is extremely
difficult, especially more recently, where the route utilisation
strategy that the government has launched through Network Rail
is getting very good now at identifying where the capacity is.
You would expect the department to fill that capacity as well
as it possibly can for franchises so that they can generate premia
from letting those franchises and not leave white space available
that could be otherwise used. They will surely specify that in
the franchise to maximise the use for that. Trying to identify
outside of that process, where there could be some hidden opportunities,
is very much driven by the availability of the capacity on the
network, which is in a lot of areas, particularly in the south
east, heavily constrained.
Mr Franks: It is a risk that we
have to assess and take a view on. There is one other point on
open access which has not been mentioned yet and that is the whole
issue about does the capacity exist. If there is some capacity,
if you put more services into that capacity, does it have a negative
impact on our ability to operate a reliable railway? We have a
very good example at the moment that is affecting our Central
Trains franchise where there is an open access proposition, where
we have been working with Arriva Trains to improve the performance
on the route between Wolverhampton and Shrewsbury. We have freed
up some space on the route to enable the railway to work more
effectively and more efficiently. That has created potentially
a slot for a train operator to come in. There is a bid to use
that slot. Whilst we do try to assess the risks, that is an example
where it is very difficult for us because we are trying to deal
with one objective, to run a reliable railway, against another
objective that suddenly creates an opportunity that can damage
what we are trying to achieve.
Q33 Mrs Ellman: Do you feel that
some steps should be taken to reduce the possibility of open access
competitors?
Mr Franks: I think competition
is very good. If open access operators are to come on to the network
capacity must exist. The cherry picking point which has been mentioned
also needs to be dealt with. If those two things are taken into
account and resolved properly, competition is good.
Q34 Mrs Ellman: Are there any other
views? Mr Smith, earlier on you spoke about competition through
franchising being good in that it looked at the needs of passengers
but do you feel the existing franchise system really does look
at passenger interests and innovation rather than the financial
needs of the Treasury?
Mr Franks: Could I give another
example? We operate the Gatwick Express franchise which is operating
in a highly competitive way with two other operators, First Capital
Connect and Southern. That franchise is leading the national passenger
survey scores and has done for almost two years. It is innovative;
it is creative; it looks after customer needs and it delivers
what airport users want. As a consequence, that business in a
highly competitive environment has grown 42% in terms of its revenue
over the life of the franchise so far. There is an example where,
if you travel on that railway, you will see a very high quality
railway, recognised in this country and outside of this country
as a success.
Mr Smith: Despite being the owner
of one of the franchises he has referred to as being in competition,
I am very happy to endorse what he says both in responding to
Mrs Ellman's question and what Mr Goodwill referred to earlier
on about competition. I think there is competition where the underlying
demand will bear it and support it. The main line between London
and Brighton is a very good example where three of the four train
companies here actively compete with each other. It is in the
interests of passengers. Most of the franchises we have operated
have been in the London and south east area and we have always
been used to there being alternative train routes and opportunities
for passengers. It is not something that we are shy of. I would
agree with Mr Franks that it does help overall to push up standards
and responsiveness. Specifically as to whether the franchising
process looks to the interests of passengers or the Treasury,
I am not sure to what extent it is for us to answer that but I
do think it does require us to look at the needs of passengers
very clearly in terms of what we have to submit for bids. We are
evaluated on that from the point of view of the robustness of
the service quality that we will offer. Once we are in a franchise,
we are held to account by a variety of measures for how customers
perceive and rate our service. Above all, we are driven by the
fact that we carry the revenue risk and we need and want to get
people on trains.
Mr Metcalfe: We are talking about
competition within the railway but we compete very heavily against
the airlines. An example of one of the things we did as a result
of that was putting in Wi-Fi on the trains and internet access
on the trains at the end of the previous franchise before we knew
we had the new franchise, because we believed it was such an important
thing to do, to try and do something different to the airlines
and attract airline passengers. That is an example of innovation
and a way we can improve passenger benefits. I also endorse Mr
Smith's point. I think the current franchising model and the very
clear focus on value for money and premia do make those examples
of innovation more and more difficult.
Mr Lyons: There is an element
in the franchising process that could be looked at more closely.
There is very full consultation during the process. Inevitably,
when the specification comes out from the DfT, some very hard
decisions have to be made. In many cases, they are as much about
the amount of capacity on the network to squeeze every service
that has been requested. What I think could be improved is sometimes
where the groups have made bids for extra services. This does
not seem to be working in a perfect manner and there is often
disappointment. Services people thought they were going to get
are changed, reduced or whatever. I think that is a process that
the DfT could probably improve on in the next round of franchises.
Q35 Mrs Ellman: Is it a really serious
proposition for the department to say they would not renegotiate
contracts? Do you take that literally?
Mr Smith: Yes.
Q36 Chairman: Are you saying it is
a real threat?
Mr Smith: It is clearly meant
to be that.
Q37 Chairman: Mrs Ellman is not asking
you whether that is what it is meant to be. Civil servants are
often very good at telling us what things are meant to be. Is
it a real threat to you?
Mr Smith: It is a real threat
that we must take account of when we bid because, if we disregard
it as a threat—in other words, we do not see it as a real
threat—we run the risk of putting in a commercially untenable
bid, which is not in our interests.
Mrs Ellman: You do not somewhere in your
mind think that maybe it would not happen?
Q38 Chairman: Mr Lyons, if they have
a problem with you, are they genuinely going to let the entire
service collapse?
Mr Lyons: We have had examples
of that already. In the history of franchising we have seen Prism
disappear in the very early days. South East Trains is another
example where a franchise was stripped from an operator because
of the perceived unsatisfactory service or a belief that the subsidy
being asked for was unreasonable. I think there is plenty of evidence
that if those operating franchises are not working well they are
going to lose them.
Mr Franks: I hate to admit this
but we ran a number of franchises at our own cost. Scotrail, for
example, at the end of that franchise time, was costing National
Express Group a lot of money so we do understand the threat.
Chairman: It is lovely to hear there
are all these philanthropists in business.
Q39 Graham Stringer: If I can go
back to the very first point, Mr Austin made a comment that one
of the justifications for franchising for infrastructure of the
railways was value for money. Is that not at odds with the facts?
The railways are costing us five billion when they were expected
to cost us nothing in this year. When you compare the franchising
system, say, with the bus industry where costs have gone down,
in the rail industry the franchise costs are going up. Surely
the answer is you are terribly inefficient?
Mr Austin: I do not think so.
In general terms, railway costs in terms of franchise support
for the last recorded year, 2004-05, are just over a billion and
that is down. It is difficult to make comparisons because of the
impact of network grant which has shifted some of the subsidy
from train operators direct to Network Rail. In general I would
have said it is moving in the right direction. The other thing
which we reflected in our paper is the difference of the balance
between those franchises that receive subsidy and those that pay
a premium. We have already moved from a minority position of around
15% five years ago to a point today where about a third of the
franchises are paying premia. Within a year or two that will be
up to about half. That is the inexorable move away from subsidy
towards premium.
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