Examination of Witnesses (Question 40-59)
MR CHRIS
AUSTIN, MR
PAUL FURZE-WADDOCK,
MR JONATHAN
METCALFE, MR
TOM SMITH,
MR DAVID
FRANKS AND
MR ADRIAN
LYONS
5 JULY 2006
Q40 Graham Stringer: Professor Nash
is talking nonsense, is he, when he says that costs have grown
substantially because, with the greatest respect, subsidy is a
completely different issue, is it not, to costs?
Mr Austin: Professor Nash rarely
talks nonsense. I would not challenge that. There are some real
costs which, for example, the train operators have had to meet,
partly as a result of increasing outputs, carrying more people,
running more trains, which is good; partly as a result of external
factors—for example, the costs of insurance, policing and
fuel in particular which have gone up way beyond the rate of inflation.
Mr Franks: Could I give a summary
of the cost base of one of our TOCs? It has a cost base of about
450 million. 150 million of that is Network Rail charges. That
is outwith the grant contribution that we do not see through the
TOC. About 100 million of it is to pay for the rolling stock.
The true variable costs that we have within the business are in
the region of about 25 to 50 million of the total cost base. In
terms of what we are delivering, it is all driven really by the
timetable. The timetable requires a number of trains, a number
of drivers and a number of staff on trains and at stations so
the true variable element of a cost base for a train operating
company is very small. The big costs are Network Rail and ROSCO
costs.
Mr Metcalfe: One of the ways we
measure cost is to look at costs and measure them against the
number of passengers carried or the number of passenger miles
operated. If you look at it on that basis, because of the extra
number of services and the significant increased number of passengers,
costs are reduced over time, particularly if you then build in
the increased premia or reduced subsidies as well.
Mr Franks: Every time there is
a franchise competition, if you do not have your cost base in
good order, you do not have a chance of winning the franchise.
The franchise process in its own right helps to keep the costs
under control.
Q41 Graham Stringer: If we exile
Professor Nash to some academic cloud cuckoo land, can we do the
same with Mersey Travel who say that if there were local decisions
made they would save 33 million?
Mr Franks: I have not seen their
submission but I would anticipate that they think they can save
that from the Network Rail cost base.
Q42 Graham Stringer: Not from the
franchise?
Mr Franks: Not from the franchise.
Q43 Graham Stringer: Is that the view
of everybody else? Your costs are less. The subsidy to the rail
system is five billion when it was expected to be nothing. Without
the franchising part of the rail system, are you saying that the
costs would be less and you are helping rather than hindering
in the overall costs and subsidy to the railway system?
Mr Franks: I would suggest if
there was the same rigour and competitive challenge to Network
Rail the costs to the industry would be lower. If Network Rail
through their five year control period went through the same process
we went through every time there is a re-franchising opportunity,
there would be a much firmer challenge to the cost base of the
industry.
Mr Metcalfe: Post-Hatfield there
was a need to significantly invest in the network, in the infrastructure
and do a lot of the work in investment that has gone on over the
years. There was quite a backlog that has been feeding the Network
Rail costs over recent years.
Q44 Graham Stringer: You are saying
that is coming out in your costs?
Mr Metcalfe: It is coming out
in the overall, total industry costs yes.
Q45 Graham Stringer: Some of it is
coming out in your costs as well in charges from Network Rail?
Mr Metcalfe: Yes.
Q46 Graham Stringer: Let us approach
the question in a slightly different way. We have just finished
taking evidence on a bus inquiry. Many of the companies you represent
run buses as well. Why do you not make the same return as the
bus arms of your organisations? Why is your profitability less?
Mr Franks: Because if we were
to put in margins that are higher than we currently do we would
not win the franchises.
Mr Smith: It is the competitive
pressure of franchising.
Mr Metcalfe: In the early franchises,
if we go back to the beginning in the mid-1990s, the margins were
much higher and the equilibrium or the pendulum has swung back
to the other end. That is why it is such a competitive environment.
Q47 Mr Wilshire: Can I ask those
who have put in a bid for a franchise what they reckon it now
costs to do that?
Mr Franks: In the National Express
written evidence we quoted what we believe it costs to run a bid
now which is in the region of £5 million. It is clearly commercially
sensitive but I would at any point be prepared to run through
with anybody the detail of the breakdown of that cost so that
you can see exactly where those costs go.
Mr Smith: Our view would be that
it costs a little less than that, based on what we have spent
in bidding for franchises. We are certainly talking about £3.5
to £4 million for a bid for a franchise.
Mr Metcalfe: That is our experience:
between £3 million and £4 million.
Mr Furze-Waddock: Similarly, closer
to David's estimate of five million. It will depend to some extent
on the franchise you are bidding for and how much information
is necessarily provided in advance as to how much cost you incur
in developing the bid.
The Committee suspended from 3.29 pm to
3.37 pm for a division in the House.
Mr Wilshire: I am sure our witnesses
have had time to work out the next question so I will not ask
it. I would just say that if we were to pursue the matter of how
those costs are made up it would use the rest of the time. I wonder
whether it would be appropriate if those who have given us a figure
would be willing to submit a written note on exactly how those
figures are made up to save us the time of wading through a lot
of information.
Q48 Chairman: Would you be prepared
to do that? If you do not want any of it published you would have
to make that clear when you give us a supplementary note.
Mr Franks: That is fine.
Chairman: We would need a fairly good
explanation for why you did not want it published, so it is no
use just saying "I don't want you to say this".
Q49 Mr Wilshire: What I want to ask
is when we see that information I would like to ask, if those
are significantly bigger figures than the costs some while ago,
why have they gone up? Are there things that you are having to
spend money on that you think you should not have to spend money
on?
Mr Franks: Can I make one very
important point about why I think maybe that is the case for First
Group and National Express Group. I will let Mr Furze-Waddock
answer for himself. One of the big differences for us is the Competition
Commission costs. It seems every time there is a franchise proposition
there is a referral to the Competition Commission and for us,
in the number I quoted, that is almost £1 million estimated
for the next round of franchising, so that is a big number and
growing. That is one issue. The other issue is it is a competition,
you do have to prove to the Department for Transport in the bid
process that your bids are deliverable and to do that there is
a very onerous requirement through the bid process. I have brought
with me, and you may or may not have seen it, a copy of the South
Western franchise evaluation process which actually amounts to
nine pages of what you have to do to prove that your plans are
deliverable. There are 22 plans in the South Western Trains' franchise
tender. Each one of those is measured on three different criteria
and you have to set out very clearly how you are going to do that.
As I say, that process has evolved over a period of time. I think
it is like that because the Department are very concerned about
the risk of a judicial review on its process and that is driving
the requirements higher and higher and, therefore, the costs to
us go up accordingly.
Mr Furze-Waddock: I would agree
with most of that. There is a high level of competition costs
in there. Very often it is a waste of time going through the Office
of Fair Trading and that getting referred on to the Competition
Commission itself, which does then handle things extremely professionally
but it is an extremely costly process. We spent very nearly £1
million on one bid just going through that competition process.
Q50 Chairman: What changes would
you ask for?
Mr Furze-Waddock: I think some
recognition that the franchising process already identifies a
service level that operators have to sign up to and there is no
varying that without going back to the Department for Transport,
that there is a high degree of fares regulation both directly
and indirectly, that there is very little substitutability between
bus and rail, apart from a very few exceptions where there are
overlaps that could be substitutable, and also to recognise once
and for all that the car is the big competition, which they singularly
fail to do every time and they just look at the small picture
of some small overlaps failing to recognise that our big competition
is the car.
Mr Franks: Can I just add to that.
I support everything Mr Furze-Waddock said there. What does not
happen is there is no case law, no precedent. Every time you enter
into another franchise competition, if you are referred to the
Competition Commission you start again going through all the old
arguments that you have used and gone through previously. If there
was case law and it could effectively be taken off the shelf and
actually used it would save an enormous amount of time and effort.
Mr Smith: Can I return to the
question about bidding costs as such. The last franchise that
we actively bid for was the integrated Kent franchise which was
submitted a year ago. Each copy of our bid, and we had to supply
six copies, consisted of 22 lever arch files, so it was very sizeable,
it took up two rows of a normal cupboard, and I imagine my colleagues
who bid on that franchise put in something very similar. That
is driven by the Department's requirements which in turn is the
major driver of the costs. You asked are there areas that we think
should be reduced and I think the answer to that is yes. I do
not believe the Department needs a complete encyclopaedia of how
to run a railway in order to evaluate a bid. It certainly needs
detailed and robust financial information and it needs to be able
to satisfy itself that a prospective franchisee, a bidder, has
thought about the operational and commercial challenges of the
franchise in question to a sufficiently robust degree to be able
to pick up the threads of running the business and make a success
of it and deliver their financial outcomes. I do not believe they
need the volume they are requiring at the moment and personally
I feel it has gone that way because the Department have allowed
themselves to be consultant led, consultant driven, in terms of
specification of requirements, and if they could wean themselves
off that I believe—
Q51 Chairman: It is not just the
Department, is it? There is evidence from Govia saying bidders
often spend £2 million on consultancy fees alone in the course
of bidding for a franchise. Is that typical?
Mr Smith: Yes, it is. What I am
talking about is what is it that has produced a system that requires
us all, including the Department, to spend that much money. I
believe it is the Department's approach and specification of what
they want in bids returned to them. If we could get back to some
midpoint between where we are today and the very first round of
franchising undertaken by OPRAF when bids were one lever arch
file, if that, then I think—
Q52 Chairman: There were problems
with that, Mr Smith, as you know.
Mr Smith: That is why I am not
suggesting we go all the way back to it but I think there must
be some middle point that reduces the burdens on the players on
both sides of the industry and reduces the costs.
Mr Metcalfe: I would certainly
endorse the point about some sort of equilibrium or balance because
it has swung from one volume maybe half an inch thick to 22 ring
binders and I think the answer lies somewhere in the middle. If
you look at the straightforward example of KPIs, the original
franchises did not have KPIs and current franchises have anything
up to 122 KPIs. Again, I think it is the extreme swing and it
is finding the right balance in the middle of all that.
Q53 Mr Wilshire: Could I ask Mr Lyons
and Mr Austin a question that arises out of what we have just
heard. Is this escalation of paperwork anti-competitive in that
it makes it ever more difficult for others to break into this
system because of the amount of cost the first time they try and
enter the bidding process?
Mr Lyons: I have to be quite honest
and say at this stage there is no evidence of that as you can
see from the recent franchises. I think something has to be done
about it just as a matter of sound process, not however to discourage
people but to make sure that when you are tendering for franchise
and the DfT is specifying it there is much greater clarity of
what is required. I think the sheer bulk of information the DfT
is asking for often gets in the way of that particular aspect.
Mr Austin: I think it is one of
the barriers to entry or one of the things which make it more
difficult for completely new operators to come into the industry
because it is quite a daunting amount of information which is
required. I think the answer to your question is yes.
Q54 Mr Leech: Just following on from
that, is there not an argument to make completely the opposite
argument by saying if you have all got to put in all the information
every single time then existing operators who have existing franchises
are not going to have a competitive advantage because they will
have already given the background information about running franchises
whereas a new operator might have to do all the existing work
and all the pre-work that you have already put in?
Mr Furze-Waddock: In the new template
franchise agreement the Department has modified it substantially
to make it a requirement of the incumbent franchisee to provide
all of that information on a very regular basis. That is probably
something we will end up coming back to because, again, they have
gone from one extreme to the other and we now have a monthly meeting
with the Department to monitor performance, both financially and
operationally, and as time goes by that is going to become extremely
onerous for the Department to resource that and for us to resource
it. Again, it has gone from one extreme to the other. So long
as there is a requirement for the incumbent operator, as there
now is, to feed information into a repository so that when it
is time for re-letting that franchise there is a source of data
then that will make life easier and at that stage it will reduce
cost, I suggest.
Q55 Mr Leech: What, in your view,
is a happy medium?
Mr Furze-Waddock: We are now testing
the new franchise agreement. Certainly in the early days—we
are now in the first three or four months of two new franchises—meeting
on a monthly basis is not unreasonable because there are so many
issues to manage through and commitments that have to be managed
with the Department, but as we get into a steady state to have
to meet and the risk of micro-management on that degree of regularity
with two franchises that are there to deliver premium, to generate
revenue, that puts a tremendous onus on us to generate that sort
of growth and put the quality into the business, is probably going
to become far too difficult for both parties to manage.
Q56 Mr Goodwill: It is obvious there
are many obstructions to new entrants coming in. Would you say
that the reliance on track record in the pre-bidding process—70%
of weight is given to track record—is another disincentive
and obstacle to new entrants coming in as we have seen since privatisation
very few new entrants coming, other than one or two from abroad
maybe?
Mr Metcalfe: I think the whole
issue of how existing incumbents are judged has moved around quite
a lot over the last few years and there have been times when existing
incumbents have had no benefit or real advantage over anybody
else bidding for a franchise. There have been some changes to
that to try and reflect the reality that the existing incumbent
does have experience. I guess my wider worry about people bidding
and new entrants is partially about the cost and complexity of
bidding but it is also about the very tight, very competitive
nature of franchises now and the very low margins driven by the
very clear focus on lowest subsidy or highest premium and there
is a wider question about the appetite and extent to which people
will want franchises going forward, and I think that comes back
to the issue about balance and equilibrium in the cycle.
Q57 Mr Goodwill: You mentioned one
of the major costs borne by the rail industry is the cost of Network
Rail, particularly post-Hatfield. Have the operators looked at
the possible feasibility of including the maintenance of the track
by the primary operator running on that track within the franchise
operations so that maybe you could be more successful in controlling
costs and improving standards of maintenance and improvement than
Network Rail which, once again, has come cap in hand to the Exchequer
for £8 billion this week?
Mr Austin: Can I start off with
a general point and then colleagues can come in with specific
examples. In general, no, we have not. We are happy with a system
which enables us to focus on the passenger rather than the engineering.
I think that is the first point to make. The second thing is working
together rather than taking over has been an important direction
so the establishment of integrated control centres, or joint control
centres, has been one area where a lot of the practical benefits
of integration have been brought about without any transfer of
structure or ownership.
Mr Franks: I would make a similar
point that one of the real benefits of the franchising process
is that our job is to look after the interests of passengers.
That clearly is right at the forefront of our mind, it is what
enables our business to survive and it is there for us to do.
That said, in the past it was possible for any train operator
or any other company to bid to do the maintenance of the infrastructure
but that is not a possibility now because Network Rail by policy
has decided not to let that be outsourced but to do it within
their own organisation.
Q58 Mr Goodwill: Do you feel that
Network Rail is a lean, mean machine that is delivering value
for money in terms of the amount of improvements that we are getting
for the amount of cash going in?
Mr Franks: I made a point earlier
on about that. If Network Rail went through the same competitive
process that train operators had to go through it would be probably
leaner than it is now.
Mr Furze-Waddock: I would agree
with that. I can give an example of a Network Rail system and
process which I think typifies an approach, which is the moment
they cost projects it has to go through what is called a Grip
process, Grip 1, 2, 3, 4, and up until the third stage of this
they factor in a 35% contingency. You are talking about projects
of maybe five million, 20 million, 100 million, and to have a
35% contingency within that sort of number might be prudent, it
might be necessary in some cases, but it strikes me as being a
very lazy way of coming up with quick, reliable estimates to put
infrastructure change through. It takes a long time, it is a very
cumbersome process, it costs quite a lot of money and even at
stage three, which is what we would normally consider to be about
to press the button, you end up still with a huge contingency
built into the numbers so you cannot really rely upon it. I think
that is an example of how they have got this cumbersome process.
Q59 Chairman: You do not think that
is dictated by experience?
Mr Furze-Waddock: They would no
doubt argue—
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