APPENDIX 13
Memorandum submitted by the Office of
Fair Trading
We would wish to make the following points:
1. Public transport is obviously an issue
critical to consumer welfare and the markets affected by rail
franchises represent a significant proportion of the economy.
Competition analysis should therefore be brought to bear to make
these markets work well for consumers—here, the passengers.
The OFT equally recognises the importance of balancing other public
policy considerations, outside its direct remit, in this sector.
2. As outlined below, the competition authorities,
together with other public sector bodies, have worked to improve
the existing regime of competition scrutiny of rail franchise
awards, and its smoothest possible interaction with the other
aspects of the overall franchise process.
3. Notwithstanding these efforts, we are
not convinced that the current system is fully effective. We therefore
welcome the Committee's inquiry into whether the current regime
works well from various perspectives, including from the standpoint
of competition and consumer welfare. The OFT seeks to maximise
the use of its resources to the benefit of the consumer, while
minimising taxpayer and private sector costs.
4. In particular, the current regime does
not easily permit competition considerations to be accounted for
at the point of franchise design; the merger control process is
initiated only at the award stage. And yet, in our view, consumer
welfare considerations should also be given proper weight at the
inception of the process: at the design (including franchise remapping)
stage.
5. The actual award of a franchise raises
public policy issues of which competition considerations are a
critical, though not the only issue, and where there may be short-
and long-run trade-offs. The current regime applies competition
scrutiny by treating franchise awards as if they were private
merger activity: the Railways Act 2005 specifies that franchises
awards are mergers for the purposes of the general merger regime
of the Enterprise Act 2002 (EA02). As the rail franchising process
has peculiarities not shared by private merger activity, this
approach means that competition factors may conflict with other
public policy considerations in the rail transport sector. There
is no formal integrated mechanism for resolving such tensions,
so that efforts to adopt a "joined up" approach across
government are complicated. And, at the same time, the system
generates very substantial public and private costs.
6. Part of the OFT's concern relates to
the timeliness of competition scrutiny and the impact this has
on remedial action. Effective competition scrutiny must contemplate
the ultimate possibility of enforcement. By involving the mechanisms
of EA02 merger control late in the process, remedying adverse
effects becomes difficult, particularly where restoring inter-modal
competition (bus or coach vs rail) may be concerned. In such cases,
the cornerstone of merger remedy policy—structural remedies
such as partial divestment or prohibition—may be unattractive
or indeed impossible in practice to implement. Other tools of
intervention open to the competition authorities for example price
and service regulation of commercially viable bus or coach passenger
services to restore lost inter-modal competition in the franchise
area incurs significant regulatory costs.
7. In our view, substituting competition
with regulation in an unregulated sector is neither effective
nor desirable. This is especially so when regulation must be crafted
within the tight deadlines of merger control. It is, of course,
settled government policy that the majority of UK markets should
be subject to open competition, and only a minority subject to
price regulation. The OFT's own experience of the unintended adverse
consequences of price regulation is apparent in the remedy it
recommended when National Express Group (NEG) acquired Prism Rail
plc, and thus the Stansted Express line: it appears to have had
the unintended effect of depriving consumers of cheaper coach
tickets between Central London and Heathrow airport.
8. All relevant public sector parties have
actively sought to resolve the difficult issues of timely competition
scrutiny and cost mitigation in the rail franchise process:
— in the early period of implementation
of the EA02, notification of franchise awards was voluntary, and
investigations were conducted ex post, in some cases from complaints.
This approach culminated in the reference to the Competition Commission
(CC) of the award to NEG of the Greater Anglia franchise, which
NEG had already begun to operate. Concerns were raised that the
competition authorities were potentially frustrating government
policy to award a franchise to a given bidder.
— subsequently in order to accommodate
provision of first- and secondphase merger review before the operation
of a franchise by a successful bidder, the OFT agreed with the
SRA that it would conduct competition review of all pre-qualified
bidders, and the SRA made it compulsory to seek merger clearance
from the OFT. This led to review of three to five bids for each
franchise award, all but one of which would be losing bids and
thus "hypothetical": the public and private costs of
OFT review were incurred for each bid (all but one unsuccessful),
as were the costs of (partial) CC review in those cases. This
regime applied from late 2004 to 2005, covering the Intercity
East Coast, Integrated Kent, Thameslink/Great Northern and Greater
Western franchise awards. The concerns as to regulatory burden,
shared by all, led to a concerted effort by OFT, CC, ORR and the
Department for Transport to reduce the unnecessary costs of this
revised approach.
— Accordingly, for the pending South
West Trains franchise, we have agreed to revert to a variant of
the initial systems to that the OFT only examines the franchise
award once it has been made, albeit with undertakings to prevent
operation of the franchise and/or changes to road transport services
until OFT (and where applicable CC) review is complete.
The OFT believes that its own experience raises
important questions about the costs and benefits of the current
system. It would be happy to explore these issues further with
the Committee and other stakeholders as may be appropriate.
14 July 2006
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