Select Committee on Transport Minutes of Evidence


Memorandum submitted by the Chartered Institute of Logistics and Transport

  The Chartered Institute of Logistics and Transport in the UK—CILT(UK)—is the premier institute for professionals working in transport planning, operation and administration. Its 20,000 members include directors, managers and other individuals working in and around the rail industry. The Institute is uniquely placed therefore to comment objectively on the issues raised by the Committee's Inquiry.

  The Institute's submission is structured around the specific questions asked by the Committee in their formal notice.

1.   What should be the purpose of passenger rail franchising?

The purpose of franchising

  In the Institute's view, railway passenger franchises should deliver a stable, safe and efficient service to the customer and at an affordable price consistent with any wider social or planning objectives. The franchising of those services should transfer much of the associated provision risk to the franchisee, but only as far as this is consistent with achieving good value for money for the franchisor.

Is the current system achieving that purpose?

  Rail franchises grant monopoly rights to operate specified services on specified rail routes and are awarded by central government to private sector franchisees for a specified period of time. The franchise either carries the right for the franchisee to receive subsidy or a requirement to make payments (premium) to the public sector over the life of the franchise. Franchises are about the operation of domestic (not international) passenger services, generally on the national rail network.

  The franchise operator deals direct with the travelling public—and is responsible for the sale of tickets, the setting of some fares, promoting information about rail services, operating stations and running trains. The franchisee's incentive to maximise its fare revenue, coupled with the requirements of the franchise agreement, should encourage it to improve the quality of its service and to meet customer demand. At the same time it gets a commercial benefit from controlling cost. If a train operating company (TOC) manages a franchise well, its reputation is enhanced.

  The franchise operators are the main customers of Network Rail which is responsible for the operation and maintenance of the national rail infrastructure. The franchisee is to some extent dependent on Network Rail's quality of performance of that role.

    —  In contrast to other utilities such as water and energy, it is not expected that rail passengers can bear the full cost of service provision in all cases. Both Conservative and Labour governments have assumed that continuing subsidy will be necessary.

    —  Outright sale at privatisation would have meant "selling off the family silver". Arguably, by granting short- to medium-term franchises, Government is able to extract more value.

    —  Franchising allows for both payment of subsidy and of a premium. In its current form it also allows for the sharing of revenue with the public sector.

    —  There may be a difference between the model which could be used for long distance and commuter services (both of which can generate revenue surpluses), in contrast to regional services (which do not). So far government has chosen to use the same model for all types.

    —  Periodic competitions give government more scope to monitor and specify performance than would be the case with outright sale. This meets politicians' concerns that passenger train service is a public service.

    —  Franchising is also flexible in that government can relatively easily "remap" the country, ie divide it into different geographical areas to be the subject of franchises and thus increase or reduce the number of franchise operations.

    —  This flexibility allows for the specification of a single purpose operation such as an airport service, (eg Gatwick Express) or a mixture of services (eg Greater Western) which combines London commuting with intercity travel.

    —  Shorter-term franchises are less likely to attract private capital investment than the 20-year franchises launched in 2000, of which Chiltern is the only example.

  In the view of the Institute, there should be an examination of the effect of relatively frequent changes of employer on the performance of operator's employees (although we recognise that TUPE and provisions in the franchise agreement ameliorate these). Also, there should be an examination of whether relatively frequent changes in franchise owners and in the contractual terms of franchises have any effect on safety or whether the safety regime deals adequately with this.

2.   How well does the process for awarding franchises work?

What input do operators, passengers and other interested parties have into the design of franchised services?

  The process for awarding franchises in this second round of franchise letting has improved considerably. Early awards were notable for slippage in timescales principally brought about by changing specifications issued by the Shadow SRA and the SRA and by changes to the process. More recently strong emphasis has been placed on meeting laid down timescales and the process had become more consistent. A remaining, but declining, issue has been the lack of precision in the specification and seeking alternatives. This distracts bidders from refining their core offer to achieve the best price for the Government.

  The process has now refined to an "Accreditation" Phase, whereby bidders seek to be shortlisted on the basis of their track record, and a bid phase, when those shortlisted submit their prices for the specified services. With greater, and comprehensive, specification by the DfT, the focus is now on offering the best price for delivery of the services.

  The form of the franchise agreement has become much more standard, reducing the opportunity for bidders to renegotiate the terms and change the risk profile as bid, and thus reducing the uncertainty of the contractual position.

What input do operators, passengers and other interested parties have into the design of franchised services?

  The DfT prepares a service specification founded on the current service pattern/level with alterations to reflect current concerns over the affordability of the rail network. Thus services which appear to be poor value for money (generally those with low usage) are likely to be considered for withdrawal. This specification is then issued for consultation to "Stakeholders" and is published on the DfT website. Representations are then considered and a final specification issued to bidders within the invitation to tender. Given the emphasis on net cost reduction to the DfT, the extent of changes is generally limited. This even seems to apply where the franchise is premium paying, suggesting a reluctance to reinvest some of the premium in supporting low-use services rather than franchises generally. There appears to be no cross-subsidy between premium-paying and subsidy-requiring franchises and we are unsure whether the DfT intends to net off one against the other.

Has there been a smooth transition of franchising arrangements from the Strategic Rail Authority to the Department for Transport?

  This appears to have been managed satisfactorily as many SRA employees transferred to DfT and industry knowledge was thus retained. The processes and procedures set up by the SRA were well-founded and thus remain fit for purpose. There does not appear to have been any "change for change's sake".

3.   Are franchise contracts the right size, type and length?

Size, type and length

  Size. The cost of bidding/letting a franchise is broadly similar whatever the size. Thus the overall cost to Government and industry is less the fewer franchises there are. So there is a benefit in fewer, larger franchises. Operationally, the rail network works better the fewer inter-organisation interfaces there are. This again favours fewer franchises.

  Type. Franchises are normalising on the current model of contracts with highly specified services and with franchisees taking most revenue risk. Thus:

    —  Round one franchises were let on the philosophy of allowing franchisees to increase services where commercially worthwhile but that filled the available line capacity. Further opportunities are now extremely limited without capacity-enhancing schemes, which require major investment.

    —  Rebalancing of the risk/cost issue whereby some risks (such as GDP growth) are more cost-effectively retained by the letting authority (ie the risk premium sought was perceived as poor value for money).

  Length. Latest round franchises are generally in the seven- to 10-year length, similar to the first round. Some franchises are for longer periods, generally associated with long-term investment commitments (trains, infrastructure (Chiltern)) although the Wales & Borders franchise was 15 years to achieve stability of relationship with the Welsh Assembly Government and the Merseyside rail concession was 25 years.

What criteria and processes are used to determine the nature and length of franchises?

  This is really a question for DfT policy. It is assumed to be a balance of

    —  More frequent re-letting increases letting costs.

    —  More frequent re-letting provides the opportunity to capture the benefit of better than anticipated financial performance by a franchisee.

    —  Longer franchises increase forecasting uncertainty and thus, potentially, the risk premium sought by bidders (and hence offer value to DfT).

    —  Franchisees will generally wish to see their efforts in investing in the railway rewarded by their "enjoying" the results. This can result in a reluctance to be innovative and risk-taking in the later years of franchises. Arrangements are beginning to be put in place for the DfT to "buy" the remaining life of the investment from the franchisee—albeit this can create a contingent liability for the DfT which they have been traditionally reluctant to accept.

    —  It is often difficult to identify, at the time of bidding, the likely enhancements to be implemented after the first five years, partly because enhancements identified as a result of need ought to be implemented earlier. This results in few committed schemes for the latter part of the franchise being agreed and included in franchise agreements—especially as cost projections are more difficult for spend that far ahead.

What criteria and processes are used to evaluate franchise bids?

  Short-listing—the questionnaires submitted demonstrating bidders' track record and management processes are scored and the highest scoring bidders go forward subject to there being between three and five bidders. The rationale appears to be that fewer than three does not provide adequate competition and more than five is unmanageable and makes the bidding cost unattractive to bidders.

  Bids—This has recently been published (for SWT) on the DfT website and is broadly:

    —  Best price, subject to assurance of deliverability of the specification.

Do franchise holders deliver value for money to passengers and the Government throughout the duration of their contracts?

  This can only be a matter of opinion. The Government, as the letting agency, will seek the best value at the time of letting the franchise, measured over the life of the franchise. If the franchise price is renegotiated, this is because the Government wishes to vary the contract, eg because circumstances have changed. The current template agreement has a variation mechanism embedded in it which seeks to ensure that the negotiated price is consistent with that which would have been obtained had the change been incorporated at the time of bidding.

  It is Government policy that franchisees retain most of the revenue risk and have control over many of the fares, believing these should be set on a commercial basis. Where there are wider social/economic political considerations (as for season tickets), these fares have been subject to regulation.

Are risks suitably apportioned between the Government and franchise holders?

  This has changed since privatisation with a realisation that better value is likely to be gained if the Government retains certain areas of risk where the cost to Government of franchisees taking such risks would be high. This is typically where the risks are outside the control of the franchisee and/or within Governmental control. Thus recently there has been some amelioration of the long-term revenue risk arising from reduced GDP growth where risk is shared with Government. This has been balanced by the Government being entitled to share revenue where it is higher than anticipated.

What is the scope for improving services through franchise agreements?

  The franchise agreement allows for additional services to be run, initiated by either the franchisee or the DfT, provided Network Rail considers adequate capacity exists. The process requires the DfT formally to adjust the service specification which will trigger a change to the franchise premium/subsidy, allowing the franchisee the same "margin" on the additional services as on the core services—thus retaining the incentivisation to seek such improvements. Where commercial service opportunities are identified, a mechanism exists for these to be run without a change to the subsidy/premium level, at the DfT's discretion.

  It may be noted that the additional revenue derived from increasing capacity to reduce service overcrowding can often be less than the cost of the additional works/vehicles required. This is an area where further thought is required on how to meet passenger aspirations for comfortable travelling conditions.

4.   Do we need more competition and vertical integration?

Is franchising compatible with open access operation?

  Open access applies to both freight and passenger operations. The concept was introduced in the Railways Act 1993, at the same time as franchising. EU law currently requires freight open access and the requirement is expected to extend to domestic passenger services in due course. Given this context, passenger open access needs to be recognised, not ruled out, when considering compatibility.

  The Office of Rail Regulation (ORR) requires an open access applicant to pass a number of tests before obtaining track access rights:

    —  There must be adequate network capacity, taking into account the impact of new or additional services on performance.

    —  The applicant must demonstrate that its new services will not primarily abstract revenue from existing franchised operators. The business case needs to establish that the new service will primarily generate new business and new revenues.

  There have been a very limited number of passenger open access new entrants since privatisation, the most successful being Hull Trains.

  Over the network as a whole the opportunities for new passenger open access businesses which will pass the ORR tests are thought to be limited and therefore open access is not expected to have a material impact on the franchised industry.

  The current industry structure raises particular concerns for franchise operators about passenger open access which could be addressed by changes to the structure. Thus the DfT as the franchising authority appears to expect existing franchise operators to take the risk of new open access operation. Since the risk is not easily quantifiable this risk allocation is likely to result in a risk premium (ie increased subsidy or reduced premium). This would be avoided if DfT agreed to take separately the specific risk of revenue abstraction (although the compensation mechanism would not be straightforward).

  Another issue is that the operation of ORCATS (the industry revenue allocation model) results in an attribution of revenues to all passenger operators, including new open access operators, based on timetable factors. It is therefore relatively easy to predict the ORCATS allocations at the outset of new services. It is more difficult to predict the generative effect of new services. However, the ORCATS allocation could be changed and the modelling of revenue generation improved.

  The access charging regime applied to open access operators (freight and passenger) is based on the EU minimum requirement of recovering marginal cost so that open access operators pay variable but not fixed charges. As currently applied this means that open access operators have a lower operating cost than franchised operators with whom they share routes. However, franchise bids take into account the access charges which apply to the franchise specification and so the amount of franchise subsidy or premium already reflects this. If those access charges change as a result of a regulatory review, any increase or decrease is to the account of Government and not the franchisee. The position of open access operators is quite different as they do not receive subsidy nor pay premium and are not state subsidised if their access charge increases as a result of a review.

  A change in the access charging regime would need to be consistent with EU law, which seeks not to price open access out of the market. Such a change would not on its own remove the very different risk profiles of franchised and open access operations.

Should train, rolling stock and track operation be more closely integrated?

  The Institute would observe that this is not strictly a franchise question, but one related more to the historical development of Britain's railways. Over the years, the concept that any type of rolling stock can go anywhere has gradually been extended, but there are still notable exceptions. The most obvious of these is electrification and whether or not it is installed; other limitations relate to line curvature, the weight bearing properties of underbridges, and so on.

  But other developments have seen the emergence of more specialist railways, the Docklands Light Railway (not part of the national system) being one. Here, a cursory glance will demonstrate how different the technical (not safety) standards are, to enable it to meet a specific purpose. It might be that parts of the national network could also benefit from similar treatment, and that this might include a new north to south high speed line should that ever come about.

  In the case of specialist railways, the full integration of train and infrastructure becomes far more desirable, to avoid what could be very considerable costs incurred in attaining standards which are irrelevant to its purpose. It is thus inconceivable that the DLR could ever carry freight traffic, but that means that the infrastructure need not and should not be built for trains with 25 tonne axleloads.

  For most of the national system however there are a number of operators, passenger and freight, using the same routes and the arrangements put in place at privatisation (such as what is now the Network Code and Network Rail's licence conditions) are reasonably successful in managing track operation, rolling stock and train operation in an integrated way. The Institute believes that while integration is important, at an operational level it can be achieved within the existing structure. The Institute would suggest that the case for full integration becomes much stronger on the lines, such as they are, which need not (or cannot) be considered as part of the national system. It would also note that railway assets have a long life by their very nature, and 30 years or more is commonplace. This means that change can only be brought about slowly.

19 June 2006





 
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