Rail fares and franchises: Government response to the Committee's Eighth Report of Session 2008-09 - Transport Committee Contents

Appendix - Department for Transport response

Rail franchising—on 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 franchise—both 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 competitions.

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 14)

It remains our position that we do not renegotiate franchises.

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 bidding competition".

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 upgrade.

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 circumstances.

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

October 2009

previous page contents

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

© Parliamentary copyright 2009
Prepared 16 October 2009