Appendix - Department for Transport response |
Rail franchisingon track?
1. As we said three years ago, the current system
of rail franchising is a muddle. Within just three years, two
franchise operators have had to abandon a major franchiseboth
of them on the East Coast Main Line. Whilst we fully support the
Secretary of State in his decision to take back responsibility
for the East Coast Main Line franchise, we remain convinced that
these two high profile failures are indicative of the underlying
problems in the current franchising model. (Paragraph 7)
The Government welcomes the Committee's support for
the prompt action we took in response to National Express Group's
announcement that it will not provide further financial support
to ensure that its subsidiary, National Express East Coast, remains
solvent. We have taken steps that safeguard the interests of passengers
and tax payers.
Whilst the inability of National Express to continue
the franchise in the light of economic conditions is regrettable,
the current franchise system takes account of the fact that franchisees
may face financial difficulties. It is designed so that the core
passenger services are not disrupted if an operating company defaults,
and the costs of replacing the franchise may be recovered from
a performance bond maintained by that company.
The system has to achieve a good balance between
many different aims: it should deliver value and certainty for
taxpayers alongside protected service quality for passengers;
it must balance being affordable in the short term with investing
for longer-term benefits; it should be able to cope with change
on the network, such as major projects, and changes in policy
aims; it should encourage, rather than stifle, sensible investments
and improvements and manage them efficiently and it must deliver
acceptable outcomes under different economic conditions.
The current arrangements have evolved over the years
since privatisation as a pragmatic response to these different
pressures and, in broad terms, work well. However, any system
has strengths and weaknesses. The Department is studying carefully
the performance of the current franchise model and assessing whether
there are changes that could help the railway perform better for
passengers and taxpayers in a downturn as well as delivering well
during periods of growth. Potential changes to the current system
will be identified and consulted on ahead of the next franchise
The situation of an operating company defaulting
on its franchise should not distract from the everyday achievements
of rail operating companies working within the current franchising
system. Overall, franchising over the last decade has helped to
deliver many benefits for taxpayers and passengers alike. The
National Audit Office published its report on rail franchising
last year (The Department for Transport: Letting Rail Franchises
2005-2007), the culmination of a detailed, eighteen-month
investigation. It found that the franchising system had delivered
good value for money for the taxpayer and that service specifications
were well thought through and generated keen competition. The
National Audit Office also identified a large number of service
improvements for passengers, which have been purchased through
recent franchise competitions.
Rail passenger numbers are now at their highest levels
since the 1940s. Punctuality is over 91 per cent and overall passenger
satisfaction is steadily rising. The recent successful re-letting
of the South Central franchise, with a good outcome for passengers
and tax-payers, demonstrates the strengths of the current system.
However, a lot remains to be done to improve rail, especially
to meet the major challenges of growth and capacity. To deliver
these improvements, the Department is making record investments
in upgrading the network and the services on it.
2. We are concerned that there is a lack of information
available to us regarding the financial stability of franchise
operators. Many more franchises may be struggling to meet their
required financial agreements, without our knowledge. Any additional
failures in the franchise system, coupled with risk sharing, will
inevitably cost the Government considerable sums. We are deeply
concerned about the impact this could have on the funding for
other transport projects. (Paragraph 8)
The Department published the funds available to the
railway between 2009 and 2014 in the High Level Output Specification
of 2007, including £10 billion invested in upgrading capacity.
We continue to work hard on progressing major projects such as
the Thameslink infrastructure project, new intercity trains, electrification
plans and High Speed Two.
The Government notes the Committee's concerns about
the lack of information available to it about the financial stability
of rail franchises. The Department for Transport reviews and analyses
the operational and financial performance of Train Operating Companies
on a regular basis. Franchise agreements require operators to
supply the Department regularly with detailed and forward looking
financial information, including business plans and rolling forecasts.
Emerging issues and risks are flagged up for senior officials
and Ministers. Any such discussions and assessment of franchised
operators' finances are always commercially confidential. Public
discussion of such concerns could destabilise the market, jeopardise
services and reduce value for the tax payer.
Each franchised train operator must also have a performance
bond for the benefit of the Department for Transport. The Department
pays close attention to the ratings given to the bond issuer.
These ratings are publicly available, though the cost of purchasing
the bond is a commercial matter between the operator and its bond
provider. Should a franchise default, the Department would recover
its termination costs from the performance bond.
The cost to the taxpayer of terminating the East
Coast franchise will depend on many factors, including ticketing
revenue over the period when the franchise is publicly run, so
it is not possible to put a figure on it at the moment. But the
important point is that the Government will receive all the revenues.
Franchise termination will mean that the Department for Transport
is able to call in National Express' performance bond. This will
cover the Department's expenses incurred in taking over the franchise.
3. Privately-owned companies maximise profits
and dividends in the good times when the optimistic assumptions
of their franchise bid are met. But in hard times, when revenue
stagnates and costs rise, there may be insufficient financial
resilience to get by without default or at least significant fare
rises and reductions to passenger services such as ticket office
closures and subsequent job losses. Tightly specified franchise
contracts limit the options available to operators, and partially
protect passengers, but also leave tax payers at risk of having
to pick up the bill. The current risk-sharing arrangements mean
operators are not held to account on their promises. There is
no point in involving the private sector if it simply takes the
profits in the good times, leaving the tax payer to pick up the
tab in bad times? (Paragraph 13)
Any system faces a challenge in both giving operators
commercial incentives and protecting the needs of passengers.
The current system tries to balance these two factors firstly,
to give the private operator an incentive to innovate, keep its
costs low and grow the value of the business and, secondly, to
make sure that the important public services that the taxpayer
is funding are not cut. These protections are not just important
in an economic downturn. An efficient company will make efforts
to maximise its revenue from fares and cut its costs throughout
the franchise even when the business is doing well.
That is why the majority of fares are controlled
by the terms of the franchise agreement to rise by no more than
RPI+1%. Operators cannot increase these fares above this level
when economic times are tough and this regulation has the impact
of limiting other fares. It is also why franchise agreements contain
clear obligations on ticket office opening hours, train service
levels, punctuality, committed investments and many other measures.
Operators are held firmly to account on these obligations.
The Department also believes it is right to specify
in its instructions to bidders for rail franchises elements of
the rail service that it knows train operators have little or
no commercial incentive to carry out but which research by passenger
groups such as Passenger Focus shows as being important to passengers.
If we were to pursue a lighter form of specification this would
mean that ticket office opening hours could be significantly reduced,
stations staffed for fewer hours, cycle facilities not expanded
or station enhancement plans not implemented.
The Department seeks to ensure value for money for
the taxpayer by contractualising within our franchise contracts
elements that are offered by bidders but that go beyond our minimum
specification, especially where these deliver significant additional
benefits to passengers. For example on South Central, GoVia offered
to carry out a station deep clean programme at all non-London
stations within 18 months, which was over and above our minimum
specification. Without contractualising this enhancement we would
have had no power to ensure that this was delivered and no way
of ensuring passengers benefitted from this.
If there are concerns that franchisees are not delivering
their commitments the Department for Transport will investigate
and, if appropriate, take appropriate action. The Department has
a range of enforcement mechanisms available. If an operator falls
below defined levels, the Department can require it to produce
a remedial plan, which sets out measures to restore performance,
sets target dates and becomes part of the contract with the operator.
If the operator continues to deteriorate, the Department can ultimately
terminate the franchise. In the case of First Great Western, for
example, we imposed a Remedial Plan Notice for exceeding the threshold
on cancellations. First Great Western's performance has improved
significantly as a result. We have been clear that it is unacceptable
for train operators to reap the benefits of contracts when times
are good, only to walk away from when times become more challenging.
Most franchises are set up to ensure that after a
certain point, operators are supported during periods of economic
slowdown and in turn share their profits with the Government at
times of strong economic growth. This recognises that rail revenues
are only partly under the control of operators and will be influenced
by the national economy as well as operator actions such as marketing,
service improvements and pricing. This is sensible procurement
practice: asking operators to bear the risk of factors they cannot
control will tend to inflate the costs to the taxpayer. However,
the Department will carefully consider how these risk-sharing
mechanisms have performed in recent months and consider potential
changes before tenders are issued for the next franchise competitions.
4. The Government must continue to hold firm on
its commitment not to re-negotiate franchising contracts. (Paragraph
It remains our position that we do not renegotiate
5. We believe it is unacceptable that National
Express may be able to cling on to its remaining franchises through
the use of a 'special purpose vehicle'. The misuse of legal instruments,
such as 'special purpose vehicles', to insulate parent companies
from potential losses and legal problems as a result of the failure
of subsidiaries is sharp practice. (Paragraph 15)
It is not for Government to comment on the legal
and commercial arrangements of individual companies. However,
any company tendering for a rail franchise must meet strict standards
laid down in the tender documents and the parent company may be
required to enter into certain financial commitments in respect
of the franchise, such as a committed shareholder loan. It is
regrettable that National Express Group is not able to provide
the required financial support to the franchise in line with the
contract that its subsidiary freely entered into.
If one train operator within a group of companies
defaults on its franchise, the Department for Transport will look
at the circumstances surrounding the default of the relevant operator.
The Department would carefully consider any implications or consequences
of the default upon another operator within the group and will
look at options available. We will carefully consider each case
before we decide whether cross-default applies.
6. The Government should be willing to attempt
different forms of franchising. Now is an ideal opportunity to
keep the lucrative East Coast franchise in the public sector.
The service could then be used as a comparator for other types
of franchises, both in terms of financial viability and passenger
service quality. (Paragraph 16)
We keep open our options on the form and structure
of franchise agreements but the Government believes that the best
way to secure its objectives for the railway is through maintaining
the principle of public and private partnership. The National
Audit Office report, published in 2008, concluded that the Department
for Transport's approach to rail franchising "produces generally
well thought through service specifications and generates keen
It is the Government's intention to tender for a
new East Coast operator in due course. Indeed, it is not within
the Secretary of State's gift to retain the franchise in public
ownership without a change in legislation. Moving the East Coast
franchise temporarily to public control is the most cost effective
solution for the taxpayer. The new East Coast Main Line public
company, which will operate the franchise while it is under public
control, will continue to operate services on the current basis
and customers should see no break in service. In line with the
Committee's proposal, this will afford a substantial period when
the franchise is operated by a public sector company and outcomes
could be compared with other franchises. Such comparisons can
be useful, but their value is always limited by the variety of
business conditions and operational characteristics in different
franchises. Furthermore, keeping the franchise in the public sector
would mean that the Government forgoes the substantial premium
payable by a private operator wishing to run the service.
7. The current length of franchises does not encourage
train operators to plan on a long-term basis. It discourages investment
in the services, and contributes to train operators taking short-term
cost-cutting measures that reduce passenger service quality. The
Government should let franchises on a longer basis, albeit with
breakpoints so that contracts can be terminated at pre-defined
points where performance is unsatisfactory. (Paragraph 19)
Recent franchises have been let for around seven
to ten years, although some have been let for shorter period because
of specific operational reasons, such as planned infrastructure
change. For example, the new South Central franchise has been
let for five years ten months with a potential 2 year extension
in order to fit in with the changes arising from the Thameslink
Where appropriate, the Department is keen to let
franchise contracts for longer periods. Longer franchises can
be an effective way to deliver investment projects, such as those
on the Chiltern franchise where the franchisee has taken the lead
on key infrastructure works. Long-term contracts also provide
stronger incentives for train operators to identify and invest
in projects that generate passenger revenue. At their best, a
long-term operator is able to develop a strong relationship with
passengers and plan effectively for the future.
However, relatively frequent competitions can offer
significant benefits for passengers and taxpayers. Where expectations
or demands have changed, competitions offer an opportunity for
the public sector to specify and fund new services, for instance
more capacity. Competitions require private sector bidders to
examine the business and propose good ideas, innovations and investments
under competitive pressure. Shorter franchises are also likely
to be more robust, as they do not require bidders to take a very
long view of future revenues.
Overall, franchise length needs to strike a balance
between these competing factors. Longer franchises can offer some
real benefits for the railway, but may not be appropriate in all
Long-term planning and investment require operators
to be confident that they will retain the franchise to full term.
Discussions with operators indicate that break points (unless
they are very weak) introduce shorter planning horizons, in the
same way as shorter franchises.
8. The needs of passengers have not always been
properly catered for within rail franchising contracts. The Government
must ensure that franchises are more passenger-focused, and that
commitments within existing franchise contracts are also enforced.
It would be good if the franchise recently awarded for the South
Central line, which includes monitoring of passenger satisfaction,
and the inclusion of additional factors such as cycle and car
parking space targets, were to become the norm for future franchise
negotiations. (Paragraph 21)
The new South Central franchise is a good example
of a passenger-focused franchise. The Department for Transport
will be using the methodology used in the specification and subsequent
procurement of the South Central franchise as the starting position
for future franchise competitions. The level of specification
within the South Central franchise has ensured that the passenger-facing
improvements sought by the Department, such as additional services
at evenings and weekends, station access improvements, improved
staffing levels in London, additional help points, etc. will be
delivered by the new franchisee.
The specification of the re-let East Coast franchise
will reflect the Government's concerns to secure better passenger
services and facilities. In particular we will be seeking to secure
significant improvements to station security, to bike and car
parking facilities at stations and, where appropriate, bus interchange
facilities. We want to ensure that passenger safety is enhanced
and access to rail by other modes of transport is improved on
this key route. We will consult fully on the new franchise specification,
including with passenger groups.
One way in which more passenger-focused franchises
can be delivered is through improving facilities at stations.
That is why the Secretary of State for Transport has asked two
station champions, Sir Peter Hall and Chris Green, to advise the
Government on ways to improve stations, focussing on getting the
basic facilities right as well as considering the broader role
of stations in the future.
The review will consider and recommend the minimum
appropriate levels of service that should be set at stations so
that passengers feel confident that stations will meet set standards.
The review will look at how developments such as better station
management, future franchise agreements, Network Rail initiatives
and longer term investment can help to deliver better stations.
It will also look at what else can be done to enhance stations
as transport interchanges and community institutions.
9. While we recognise that the six-month gap between
the benchmark RPI and the subsequent fare rises could cut both
ways, our concern is that the train operating companies have taken
advantage of the mechanism to raise fares at the worst possible
moment and to a level which is out of all proportion to the real
economy. But as we noted in the previous chapter, short-termism
is built in to the franchising system as a perverse incentive.
A short-term approach and insensitive attitude towards passengers
will damage train operators' relationships with their customers
in the long-term. The system encourages and allows train operators
to take their passengers for granted. (Paragraph 25)
The Government limits most operators to average increases
in regulated fares of no more than one per cent above inflation
(RPI+1%) each year. These caps are set by a formula in each franchise
operator's contract with the Department for Transport. Train operators
set fares within these regulatory caps according to their own
commercial decisions. Southeastern has a higher cap of RPI+3%
for five years from 2007, recognising historically lower fares
than elsewhere and allowing for the investment recently made in
the Kent services. The same cap applies to Northern Rail's regulated
fares in the West Yorkshire area, which funded additional rolling
stock for Leeds.
In its Fares and Ticketing Study, published on 19
February 2009, Passenger Focus recommended that restrictions should
be placed on this flexibility. The Government recognises that,
in a time of economic stringency, it is not acceptable for individual
commuters to face significantly above-average fare increases.
That is why Lord Adonis told the Committee on 25 February that
the Government intended to remove this flexibility. In January
2010 the 'RPI plus' formula will apply to individual regulated
fares, not only to a basket of fares, in order to protect passengers
from unduly steep increases in regulated fares.
We could require operators to lower their fares,
but only if we paid higher subsidies to offset the reduction in
revenue, placing a higher burden on the taxpayer and reducing
the funds available for other things, including the single biggest
programme of investment in the train service for a generation.
The majority of rail fares are regulated and in many
cases the scope for increases in unregulated fares is constrained
by the cap on related regulated fares. So operators are tightly
controlled. The Department for Transport has not seen any
evidence that franchises which have relatively few years to run
are likely to raise unregulated fares by more than other operators.
10. The complexity of the fares structure still
remains an issue for passengers. Information on, and access to,
the complete range of fares must be available and easily accessible
to all passengers. (Paragraph 29)
The industry, with the encouragement of the Government,
introduced in 2008 a new, simplified fares structure intended
to be easier for passengers to understand. The previous wide range
of ticket types and names was replaced by just three main ticket
types with self-explanatory names: Advance, Off-Peak and Anytime.
Passengers have a number of options when buying rail
tickets. They can enquire in person about rail fares at a staffed
ticket office or from a rail accredited Travel Agent. If they
are unable to go to a staffed ticket office or simply wish to
research rail fares without leaving their home, they can make
enquires of one of the many telesales outlets or, if they have
access to the internet, they can use the National Rail website
or any of the various websites operated by individual train operators
to research the best fare for the journey they wish to undertake.
There are also independent websites, such as The Trainline or
Raileasy, which provide similar fares search facilities.
11. We welcome the removal of regulated fares
basket flexibility. No longer will train operators be able to
continue the unacceptable practice of increasing selected regulated
fares by six or seven times the inflation rate. (Paragraph 31)
The Government welcomes the Committee's support for
the removal of regulated fares basket flexibility. It will come
into effect for January 2010.
12. We welcome the Secretary of State's confirmation
that the RPI+1% formula will apply for 2010 fares. This means
regulated fares could decrease next year. It is only right that
passengers, who have borne the brunt of unacceptable increases
in recent years, should gain some respite during these difficult
financial times. (Paragraph 33)
The Government welcomes the Committee's support for
the policy of holding train operating companies to increases in
regulated fares of RPI+1%, where that formula applies, despite
the significantly negative RPI rate for July 2009 that had been
widely anticipated. Since it published its report, the Committee
will have noted that the July 2009 RPI figure was minus 1.4 per
cent. This means that the majority of regulated rail fares, including
most commuter fares, will fall in January 2010. This is good news
for passengers. A drop in fares should encourage more people to
travel by train, which is good for the economy and the environment.
Department for Transport