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
| 
