Memorandum submitted by MVA Consultancy
1. INTRODUCTION
This paper is a response to the Transport Committee's
request for submissions to advise on its Inquiry into Passenger
Rail Franchising.
MVA is exceptionally well placed to provide
informed comment, as we have been involved in rail franchising
from its outset up to the present day, having advised both the
Strategic Rail Authority (SRA) and many bidders on franchises.
Our advice has covered the whole range of issues from demand and
revenue to costs and rail operations, and included franchise bidding
strategies.
The following sections respond to each of the
main questions asked by the Committee; the last section is a summary
and conclusions.
2. What should be the purpose of passenger
rail franchising?
Historically, there has been wide variance in
the "success" of franchisees; from GNER's customer focused
approach, to Connex's operationally based approach. However, rarely
has the enthusiasm of the bidding phase been carried through to
implementation for the benefit of the rail traveller. This has
largely been because franchisees have not been sufficiently encouraged
to see franchising as an opportunity to improve their part of
the railway network during their tenure of the government owned
asset.
Government objectives from franchising have
changed markedly over the 11 year period. It started as minimum
cost subject to meeting a specification, moved through "investment,
investment, investment", and has now come close to full circle
back to minimum cost.
It has certainly achieved some successes. A
very strong growth in demand, although a significant element of
this has been due to fares regulation at RPI ¸1% (later RPI
+1%) compared to the previous British Rail (BR) increase of approx
RPI +2%. The overall cost of the railway is, however, substantially
greater than under BR.
We would suggest that the purposes of rail franchising
should be:
— To provide best value for money—government
needs to be explicit over how it measures value for money.
— Continue to bring private sector
flair and disciplines into the railway industry.
— Apportion risk appropriately to those
best able to manage it (franchise holders/government).
— Remove as much as possible bureaucracy.
We would suggest that the current system fails
to deliver any of the above objectives fully.
3. How well does the process for awarding
franchises work?
The current process is very prescriptive in
terms of many elements, especially the timetable to be operated.
In none of the cases we have seen has the specified timetable
been the best, measured by almost any appropriate criteria. Indeed,
in some cases it has been inoperable. Yet the base case which
has to be on the specified timetable is the one that is evaluated.
In theory no credit is given for offering an improved timetable
if this is even slightly non-compliant.
The change from the SRA to the DfT has not had
a major impact. We have some concern that a substantial amount
of expertise has been lost, but it is too early to say what, if
any, the impact of this has been. We do note that since responsibility
has passed to the DfT, the quality of information in the dataroom
has declined, possibly due to the DfT not having the level of
expertise required to control the provision of data by incumbent
TOCs.
4. Are franchise contracts the right size,
type and length?
Geographical structure of franchises
Recent changes in the geographical structure
of franchises has been to merge Intercity, London and South East
and Regional TOCs. This is driven by the relationship with Network
Rail and is effectively engineering led. There must be a concern
that there will be a loss of market focus, as a TOC concentrates
on commercial action in the larger revenue areas to the neglect
of regional areas. This was identified by BR as an issue many
years ago when sectors were introduced; care will be needed to
ensure the benefits of market focus is not lost. It is too early
to see any evidence either way on this.
Franchise length
A key driver behind the debate on franchise
length has been influenced by a consistent and mis-guided view
that the length of franchises dictates the amount of investment
a TOC is willing to make. In truth, as was proved by the SRA,
TOCs do not have balance sheets able to support capital investment.
Capital investment is either undertaken by the franchisee, Network
Rail or some form of bank or finance house. Where investment of
this kind is made, the funder merely needs to take a commercial
view as to whether the asset will be of use beyond the length
of the current franchise, and therefore lease payments made, or
whether it needs a government underwriting to protect its position.
In either case, there is no additional cost or risk to the TOC.
The length of a franchise should therefore be
judged purely on the basis of minimising upheaval, whilst maximising
commercial advantage. As a living operation, disruption of any
kind has a serious impact on the railway. Only now is the railway
regaining pre-Hatfield performance levels and although not as
dramatic, morale and efficiency are affected by staff morale being
influenced during the bidding process. Handing a franchise over
for a longer period also gives the franchisee a greater sense
of "ownership" and therefore being more likely to undertake
revenue investments, such as staffing levels, to maximise its
advantage.
However, from a taxpayer's perspective such
long term contracts do not represent value for money, as the longer
the franchise the greater the risk to the franchisee, which in
turn it "prices" into the bid. Especially where the
disruption and implementation of a major project interacts with
a franchise, the length of the contract should be such as to minimise
the potential interference.
Finally on this point, the franchise process
leads to change only occurring (or being determined) at the commencement
of a franchise, as any subsequent changes (unless they are financially
positive for the TOC) are sole source negotiations between government
and the TOC, which rarely lead to value for money for the government.
We would probably recommend franchises of about
10 years length, but with clear breakpoints which would depend
on continuous monitoring of quality as well as financial indicators.
Franchise Evaluation criteria
Essentially the current criteria is lowest subsidy/highest
premium subject to meeting a quality threshold. Only in the event
of close to a tie is the relative quality of bids taken into account.
Furthermore, the evaluation is based only on the base case. It
is possible therefore for a brilliant franchise bid to be rejected
if the base case was not as good as that of another bidder; this
is clearly not optimal for either the government or the passenger.
The evaluation should be based on the bidders'
preferred proposal, with the base case being required, but only
used for comparison purposes.
Service improvement and on-going value for money
Once a bidder has won, it is no longer incentivised
to deliver either value for money for government or improvements
for passengers. It merely needs to deliver what it is contractually
bound to. If track record played a higher part in the chances
of winning future franchises, then franchisees would be incentivised
to continue to deliver improvements—clearly a methodology
would be required to ensure new bidders had the ability to win,
perhaps by demonstrating track record in other countries.
Risk
The nature of franchising means that the winner
will always have the most optimistic forecasts (highest revenue/lowest
costs) subject to plausibility and quality thresholds. This means
that the winner will almost certainly have a significant risk
of failing to achieve its forecasts. This risk will have been
built into the cost of the bid by bidders, as in the long term
must the bidding costs. Over the first franchise period, economic
prosperity was significantly higher than would have been forecast
at the time of bidding. Yet, several franchises got into financial
difficulty. Economic growth is the single most important driver
of demand in most if not all franchises; the franchise process
means that TOCs take the risk for this, even though they have
no control.
The government has said that it will not bail
out a failing TOC; this may work in the context of a specific
TOC, but if the failure is a result of a downturn in the economy,
then many (maybe all) TOCs will be in a similar position, and
if the government is true to its word, then it will have to relet
all franchises at the same time, and will get lower bids for all
of them. It must be remembered that the money invested in a franchise
is small—perhaps £10 million of cash plus a performance
bond from the parent company. After a few years, if all goes well,
the owning company will have substantial retained profits, and
if the finances going forward look poor it will be prepared to
hand back the franchise. Thus, whatever it says, the government
retains risk associated with significant economic impacts.
5. Do we need more competition and vertical
integration?
Open access operation and franchising are incompatible.
Value for money and improvement should be managed within the franchised
environment, otherwise the taxpayer will lose out. Open access
competition is inevitably abstractive to the franchised railway
as a whole and the additional access charges sought do not adequately
recompence Network Rail for the additional asset usage. The reasons
that fundamentally structured the franchise railway in the shape
it is remain, and further de-regulation should be avoided.
The interface between train, rolling stock and
track operation has improved substantially since the early days
of franchising. However, more can, and must, be done by senior
managers to align the incentives of their staff. The industry
itself may still require more discourse in order to understand
whether changes to the highly divisive performance regimes could
bring benefit, but in the meantime the focus should be on delivery
rather than contractual disagreement. Vertical separation is required
by EU law; it may not have been implemented well in the UK, but
it is now being made to work, and we would not recommend another
contractual change.
6. SUMMARY AND
CONCLUSIONS
— The primary objective for rail franchising
should be to provide best value for money—government needs
to be explicit over how it measures value for money;
— The current system fails to deliver
the above objective fully;
— The evaluation should be based on
the bidders' preferred proposal not the base case which it is
currently; the base case is required, but only used for comparison
purposes;
— Track record should play a higher
part in the chances of winning future franchises so as to incentivise
TOCs to continue to deliver improvements;
— Care is needed to ensure the benefits
of market focus is not lost with the transfer from sector based
(Intercity/London and South East/Regional) to geographical based
franchises;
— We recommend franchises of about
10 years length, but with clear breakpoints which would depend
on continuous monitoring of quality as well as financial indicators;
— It is inevitable that the government
retains risk associated with significant economic impacts however
it structures franchises, as TOCs can have no control over this;
— Open access operation and franchising
are incompatible; value for money and improvement should be managed
within the franchised environment;
— Vertical separation is required by
EU law; it may not have been implemented well in the UK, but it
is now being made to work, and we would not recommend another
contractual change.
23 June 2006
| 
