Department for Transport: The InterCity East Coast Passenger Rail Franchise - Public Accounts Committee Contents

Conclusions and recommendations

1.  The Department did not undertake sufficient due diligence on the bid by National Express for the East Coast franchise. National Express promised the largest ever payment for a passenger rail franchise, but then failed to meet its profit forecasts from the start of the contract and, following the economic downturn, quickly started to accumulate losses. Crucially, the Department did not test any of the bids for the franchise against the impact of an economic downturn. The Department should always test bids in future against different economic conditions. This becomes more important with the move to much longer franchises of up to 22 years. The Department should improve its arrangements with franchisees to remove any incentive on bidders to make forecasts which are either too optimistic, thereby increasing the risk that the franchise might fail, or be deliberately pessimistic, thereby increasing their expected profits. For instance, the Department should have been more rigorous in questioning National Express on its assessment that it could grow passenger revenue by 5%-12% per annum. By any measure, this appears to be an over-optimistic assessment of the business.

2.  In public ownership, the franchise is now performing better than expected but the Department has still foregone some £330 million - £380 million of expected revenue. Unlike other train operators, which continued to bear losses during the economic downturn, National Express did not have the resources or the inclination to fulfil the terms of its contract. The holding company had accumulated more than £1 billion in debt and needed to refinance this debt following the downturn. Part of the company's solution to this was to avoid heavy forecast losses on the East Coast franchise by negotiating with the Department to leave the contract. The Department should in future take greater care when assessing the financial strength of a company to ensure it will be able to support any of its franchises that get into financial difficulty. Specifically, the Department should avoid letting franchises to heavily indebted holding companies.

3.  The Department entered into negotiations demanding the surrender of National Express's other two franchises when they could not legally demand they do so. After National Express sought changes to the terms of the contract, the Department offered a deal requiring a payment of £200 million and the surrender of the company's other two franchises. However, legal advice indicated that the Department did not have a right to terminate the company's other two franchises and so ended up leaving them in place. Contracts should give the Department a clear right to terminate a holding company's other franchises.

4.  National Express paid £120 million to get out of a contractual obligation to pay the taxpayer £1.4 billion. The penalty National Express paid to the Department amounted to less than 9% of contract value, which leads one to question whether the taxpayer has been adequately compensated. This compensation is further reduced by the extension granted to the other two franchises and the additional revenue support given by the Department. The Department should ensure that there are stronger financial penalties in contracts for failure to meet contractual obligations.

5.  The Department turned down an offer from National Express of an extra £30 million for a "no fault" exit. It judged that accepting such an offer would have increased the risk of other franchises seeking a similar settlement, costing the Department and the taxpayer £140-£280 million in the long run, according to the NAO. The Department wanted the reputational damage for National Express, of having one of its franchises terminated, to act as a clear warning signal to others. But the Department undermined that position by telling National Express just over a year after the termination that the failure would not be held against the company if it bid for future franchises. Since the East Coast termination, other franchises have been in financial difficulty, and the holding companies have not sought to hand them back. However, the Department has potentially incentivised other holding companies with loss-making franchises to terminate, rather than renegotiate, their contract with the Department, as they know doing so will cost them less and will not affect their ability to compete for other contracts. The Department should make it clear to holding companies that failure to deliver obligations will have serious lasting implications.

6.  Following a period of deterioration, punctuality on the line is now beginning to improve and investments are being made in new technology, fleet maintenance and customer service. The unfortunate recent history of the franchise may well have caused under-investment in a service described to us as the "jewel in the railway crown". The investment of taxpayers' money while the franchise has been in public ownership should help to secure a good deal when it is retendered to the private sector in 2012. We expect the Department to ensure that this investment is fully recovered.

7.  Forecasts of future passenger revenues across the rail network have frequently proved inaccurate. The high proportion of discretionary business and leisure travel on the East Coast line offers commercial opportunities to attract new passengers but makes revenues susceptible to changes in the economy. Forecasting is not straightforward as it depends on assumptions about the number and types of future journeys as well as the prices charged. However, such complications are hardly new and we have in the past highlighted the poor quality of data on passenger journeys. As more sophisticated data on passenger journeys becomes available, the Department should validate the assumptions that lie behind passenger revenue forecasts for each franchise. These should feed this into its wider budgeting for the amount of support that may be required from the taxpayer.

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© Parliamentary copyright 2011
Prepared 9 July 2011