Select Committee on Transport Minutes of Evidence


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





 
previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2006
Prepared 5 November 2006