UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 537-i

House of COMMONS

Oral EVIDENCE

TAKEN BEFORE the

Transport Committee

Rail 2020: West Coast Main Line Franchise

Monday 10 September 2012

Sir Richard Branson, Tony Collins, Martin Griffiths and Graham Leech

Tim O’Toole and Vernon BaRker

Evidence heard in Public Questions 459 - 578

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Oral Evidence

Taken before the Transport Committee

on Monday 10 September 2012

Members present:

Mrs Louise Ellman (Chair)

Julie Hilling

Kwasi Kwarteng

Mr John Leech

Iain Stewart

Julian Sturdy

________________

Examination of Witnesses

Witnesses: Sir Richard Branson, Chairman, Virgin Group Ltd, Tony Collins, Chief Executive Officer, Virgin Rail Group, Martin Griffiths, Co-Chair, Virgin Rail Group, and Graham Leech, Commercial Director, Virgin Rail Group, gave evidence.

Chair: Good afternoon and welcome to the Transport Select Committee. Before we start the meeting I would like to explain the purpose of today’s session.

There has, as you know, been considerable discussion in the media on the issues arising from the outcome of the West Coast Main Line franchise since a decision was announced last month. I thought that these issues should be discussed in Parliament before the contract for the franchise is signed.

Today, we have provided an opportunity for Virgin to explain why they are unhappy at the outcome of the franchise and to answer our questions. After that, FirstGroup will put their side of the story and answer questions from us about their bid. On Wednesday, we will be hearing from the new Secretary of State for Transport on a range of issues, which will include this one.

This hearing is part of our wider Rail 2020 inquiry, which started before this specific issue arose and which is due to conclude next month. As a Committee, we will decide what further action to take in relation to this franchise after hearing from the Secretary of State on Wednesday. We are mindful that judicial review proceedings are active and that not all of the information about the bids for the franchise can be placed in the public domain at the moment.

Do members have any interests to declare?

Iain Stewart: I would draw attention to my entry in the Register of Members’ Financial Interests. In September of last year Virgin Atlantic took me on an overseas trip to Africa to view social action projects.

Kwasi Kwarteng: I would like to refer to my entry in the Register of Members’ Financial Interests. I was on the same trip as my colleague, Mr Stewart, in September of last year.

Q459 Chair: Thank you very much. I would ask our witnesses to introduce themselves by giving their name and position in their organisation.

Sir Richard Branson: I am Richard Branson. I am Chairman of the Virgin group of companies.

Tony Collins: I am Tony Collins, the Chief Executive of Virgin Trains.

Graham Leech: I am Graham Leech, the Commercial Director of Virgin Trains.

Martin Griffiths: I am Martin Griffiths, the Group Finance Director of Stagecoach Group plc.

Q460 Chair: Sir Richard, could you tell us exactly what your complaint is? Is it to do with the process that you don’t like or is it something that has happened in relation specifically to your bid?

Sir Richard Branson: If I may, I would like to take 90 seconds and then we can open it up to questions. First of all, I would like to say thank you very much for inviting Martin, Tony, Graham and myself. I am very pleased that your Committee has decided to look at this. I would like to give a brief summary of our position.

Virgin Trains believes that, if this decision is allowed to stand, it will be bad for the country, bad for passengers on the West Coast Main Line and bad for passengers on other franchises. A successful West Coast franchise is vital for this country. A bad decision will impact the UK. Based on the Department for Transport’s analysis of the two bids, Virgin’s bid is more deliverable and is financially much more robust, yet because the DfT did not follow its own rules, the most risky bid was accepted.

For many years, and to many Secretaries of State and officials, we have said that the franchising system is flawed and that the rules and regulations should be rewritten. The Government should not run a process which rewards risk at the expense of rail passengers.

Our bid is better for customers than FirstGroup’s. It is based on running Britain’s most successful train business in the last 15 years. Our overall committed investment is well over twice FirstGroup’s at £800 million. There will be twice the number of new trains, a complete fleet of Pendolinos, three times the investment in stations and more routes on offer much sooner.

This is the fourth time that we have lost a competitive tender as the runners-up: twice on the East Coast and once on CrossCountry. On each occasion the winner went bust or they ran into serious financial difficulties. This is the first time we have chosen to contest it and we have not taken that decision lightly. This is why we have called for a judicial review as we believe the time has come for the Department to operate an open and clear franchising process that puts the interests of the customer at the heart of its decision. We are confident that, with better franchise rules, the Government would receive better bids for this and for other franchises.

There is now an opportunity to ensure that there is no repeat of these fiascos. We are convinced that it needs more than a pause in the West Coast process. That is just a sticking plaster. What we recommend is that the current rules and regulations for franchising are completely reviewed and that the West Coast franchise competition is delayed until this has been completed. I therefore hope that your Committee will immediately urge the Transport Secretary to take both of these steps. There is simply too much at stake for rail passengers and the taxpayer to make the wrong decision with the wrong structure. My partners in Stagecoach and I are happy to run the current franchise on a not-for-profit basis until such a process has been completed.

Thank you very much for listening. We would be happy to answer your questions.

Q461 Chair: Thank you, Sir Richard. You have made two important but very different points in those opening remarks. You made a very serious allegation that the Department has not followed its own rules, but you have also made a much more general statement about the franchise system as a whole, which you saw as flawed, and you said the Government should review the regulations. Those are two very different things.

You have said that the Government did not follow its own rules, and that is specific to this. Is that the real point of your objection or is it something much more general?

Sir Richard Branson: In this particular bid, we bid based on the current rules. We believe that the rules were not followed by the Department for Transport. That is why we have gone to the courts to question whether or not those rules were followed. It is very difficult because answers to the questions we have asked of the Department for Transport have not been forthcoming. We can only make these judgments based on the little information we have, but, based on that little information we have, we believe that the rules have not been followed.

Q462 Chair: In what specific way did the Department not follow its own rules?

Martin Griffiths: Just to be clear-and I would echo what Sir Richard has said-we have made a number of representations about the process leading up to this bid. Once the bid was finalised and the invitation to tender was set out, I don’t think there is any misunderstanding. The competition was set up that it was very probable that the bidder who bid the most money-the biggest premium payment over the life of the franchise-would win. We understood that at the outset. We didn’t necessarily agree with that but we knew that was the process.

However, just by bidding the most money didn’t necessarily mean that you would be the winner if there was a proper evaluation of the bid. There were two stages to that. The first stage was that the Department would do due diligence on your revenue and cost assumptions over 15 years and they would risk-adjust the bids. Even after doing that, the highest bidder may still be in a position to win and sign the contract, but at that point in time the Department’s rules, as presented and explained to us in a number of meetings, would be such that, if it believed your bid to be extremely aggressive, it would look to use a formula to calculate an amount of risk capital: i.e. what sort of guarantees would it put in place to protect the taxpayer so that, if the bid wasn’t to perform financially as was expected, then the taxpayer would be protected? On both of those counts, from what we have heard, we don’t believe that either the bid was properly risk-adjusted or that the right amount of capital was asked for from FirstGroup as part of the evaluation process.

Q463 Chair: How do you know that the bid wasn’t properly evaluated in relation to risk? What feedback has there been for you to make that statement?

Graham Leech: In answer to that point we are working from the numbers that have been publicly quoted by FirstGroup. We are questioning how the bids were evaluated and, in particular, how the risks in the bids were evaluated. From a common-sense point of view we can’t see how those numbers quoted by FirstGroup stack up.

The key number of course is the premium. What drives the premium is how much revenue you can generate. What drives the size of the revenue is how many passengers you can attract. To us, what has been said looks very risky. FirstGroup have said that they will grow the number of passengers using West Coast by 6% per year: i.e. year on year. That would take the number of passengers on the route from 30 million a year today to 66 million in the future. To put that into context, the growth that we have seen in the current franchise has been 5% per year.

What has happened in the current franchise, of course, is a complete transformation of the West Coast. As you all know, it started out in 1997 as a dilapidated railway. Through the investment in the upgrade of the line and the introduction of new trains, the service now offered to passengers is far better. It is a more frequent service with much faster journey times. That has led to this already high growth rate of 5% that we have seen in the past.

There is nothing in the new West Coast franchise that would lead you, from a common-sense point of view, to believe that the growth in the number of passengers could be at a faster rate than it has been in the current franchise because the level of change is not as great. The level of investment is much smaller, but the benefits for passengers are not going to be on the transforming scale that we have seen in the current franchise.

Q464 Chair: What feedback has there been from the Department to enable you to come to the decision that the Department hasn’t considered this matter?

Sir Richard Branson: There has been very little feedback from the Department. We have sent a letter to the Department asking a lot of questions and none of those questions have been answered.

Q465 Chair: Does that mean you don’t actually know that they haven’t done it? You just don’t know.

Sir Richard Branson: Obviously one of the reasons we have gone to court is to try to make sure that those questions are answered. Common sense and 15 years’ experience of running this railway tells us quite a lot. If you take the last three years of this franchise, where they have suddenly said that they can get in up to £2 billion more and 66 million passengers, physically you can’t get that number of passengers on the trains. They have come up with figures where they just seem to have thrown in this enormous cheque right at the end of the franchise and have somehow managed to get away with Government accepting it.

Graham Leech: There are two factors around passenger numbers that I encourage you to reflect on. The first one is the actual growth being projected, which underpins a premium payment.

Q466 Chair: My question, Mr Leech, is not so much about the substance of who is right and who is wrong. I am merely probing how it is that you know the Department hasn’t actually considered the specific point.

Tony Collins: As Graham has said, what we have done is looked at what FirstGroup have said publicly. We have looked at what the DfT has said publicly. We have applied the growth assumptions and so on into our own models and come up with a figure of 66 million passengers. Common sense says that you can’t carry those. We have had to use our own experience to say why we think this isn’t common sense. The point there is that, if we believed we could carry that many people, we would have bid that many people because we are passionate about this particular railway. We have gone through an awful lot over the 15 years and we were really determined to win this but on a deliverable basis. We were scored more deliverable than FirstGroup. On our ability to accommodate growth-an important point-our scoring was 50% higher than FirstGroup’s.

Q467 Mr Leech: In your opinion, how risky did the Department view your bid as?

Tony Collins: We took the Department up at face value. Their only financial goal was to deliver and achieve sustainable value for money. We had a number of discussions with the Department. We talked about things like margins and so on. We risk-tested our bid against economic downturns of various styles and conditions. We built in a bid that was deemed to be financially very stable, whilst still being aggressive on the things we were trying to deliver in passenger benefits. That is why we were investing £800 million in the franchise.

They viewed ours as a stable, financially deliverable bid and rated it more practically deliverable as well. We have applied those same tests in our bid to what we believe FirstGroup have delivered and we have come up with a different answer.

Q468 Mr Leech: In that case where does the £40 million figure come from, which is the money that you had to set aside to combat that risk?

Tony Collins: That is the risk assessment of our bid. They have looked at the margin we built into the bid of, on average, about 7%. They have used that as a risk assessment and said, "Okay, what’s the sort of risk in the bid?" They have looked at the deliverability of what we were planning to do with more new trains, new booking engines for passengers, which makes it cheaper for them, better passenger service and so forth. They have rated our deliverability, applied that risk assessment and worked out, through their formula, how much loan facility with bank guarantees we would have to put up, and it was £40 million.

Q469 Mr Leech: On that basis, if FirstGroup have to set aside £200 million, does that mean the Department thinks that their bid is five times more risky than yours?

Tony Collins: Yes, I guess, but, when we applied the same calculation to what we believe FirstGroup’s bid is, we came up with a much higher figure. We came up with a figure more like about £600 million.

Martin Griffiths: If I can add to the comments I made at the beginning, we understood or we thought we understood the evaluation process. We could have if we had wanted to-we didn’t because we wanted to make a bid that was deliverable and robust-but we ran all of these sensitivities and we knew the impact on loan facility and what it would look like if you made a bid that was extremely risky. Part of this challenge is, "Please could you explain to us how you calculated the loan facility because, based on the numbers that we have available to us, the numbers should be much higher." Had it been much higher, like £500 million or £600 million, would the franchise have been awarded to FirstGroup? It may have been. Maybe FirstGroup would have said they would have put up £500 million or £600 million. I can’t answer that question, but that is a big question to answer.

Q470 Mr Leech: Is that figure and the fact that it is way above the £200 million that they are expected to put up part of your case to the court?

Martin Griffiths: It is fundamental to it.

Chair: That’s a fundamental part.

Sir Richard Branson: For instance, if you are renting out your house and you don’t take the person who offers twice the rent but says they will pay for it in 10 years’ time with only a small deposit, particularly when you have been burnt doing that three times previously, it doesn’t make sense. What is happening here is very similar. They are saying that they will pay a big cheque in the last three years. If you are willing to accept that in the first place, to protect against that you would need a lot of money. A shareholder of FirstGroup could say, "We know the absolute downside is £245 million of equity and bonds. We will make £600 million or £700 million over the next 10 years, and over the last three years we can choose to lose the deposit and just walk away." They can walk away from the £2 billion that they have suddenly said they can make in the last three years. The money that they can make in the last three years is completely unrealistic, whereas Virgin has put in a realistic bid.

Graham Leech: The risk is to the taxpayer because that £2 billion is the premium payments they are saying they will pay to the taxpayer. The risk is with the taxpayer rather than with FirstGroup.

Chair: Yes; we appreciate that.

Q471 Mr Leech: In your opening statement, Sir Richard, you said that you thought the franchise system was flawed in principle. I would tend to agree with that. As a regular user of the West Coast Main Line, I would like to think that the service on the West Coast Main Line could be a major contributing factor as to whether or not an organisation retained a franchise. How could we have a franchise system that would be fair and open to real competition if you can only take into consideration how well a particular operator has operated that franchise?

Sir Richard Branson: The most important thing is that it should take into account good ideas. Originally, when we bid, we came up with the idea of the Pendolino trains, and that was taken into account. Today, under the current system, if we came up with something radical like that, we would be penalised for it. We are penalised for the fact that we are willing to spend £800 million against FirstGroup’s £300 million on new innovations this time. Quality is extremely important and financial deliverability is absolutely critical, having seen what has happened twice on the East Coast Main Line, with First Great Western and CrossCountry. One or two other franchises now seem to be in the same state.

Tony Collins: One of the things that worked well in our view was the OPRAF-style model right at the start of rail privatisation. It allowed varying bids. It allowed bids to be different. It set a base spec and said, "Bid what you want to bid", but they evaluated the bids against each other. In this current process, the bids are not evaluated against each other but against a comparator model created by the Department for Transport. If that model is wrong, it will come out with the wrong answer. From all my experience in procurement over many years, you absolutely look across all of the bids and see what each one is offering and you evaluate across all of those bids.

Q472 Kwasi Kwarteng: I know we don’t have much time so I want to focus on this actual process and the fact that you have gone to court. Am I right in saying that this is a profitable business for you?

Sir Richard Branson: It is profitable at the moment, yes.

Q473 Kwasi Kwarteng: Clearly you are an extremely famous and well-regarded businessman, but to the man in the street it might seem that you are taking this badly. You have lost a bid; it’s a profitable line, as you suggest. You probably thought that you could get a slightly better return by putting in the bid that you did. It clearly wasn’t high enough to win the actual bid, and now, as a consequence of the bid being given to someone else, you are resorting to legal-some would say heavy artillery-tactics to try and get your own way. You are using your prestige and fame to try and force the Government to change their decision. People might well say this. What would you say to someone who made that objection?

Sir Richard Branson: I would simply say that I have created a number of different ventures, from Virgin Atlantic through to Virgin Trains and others, with the principal aim of making a real difference to these sectors and creating something really special. The profit motive is actually not that important to me. I am lucky because I can afford breakfast, lunch and dinner for the rest of my life. What matters to me is the fact that I have just been at Euston station and the staff 100% want to see Virgin carry on running the network. All the passengers are coming up and saying they want us to win this.

We walked away when we lost CrossCountry. The staff have been tweeting me over the last three months saying, "Why didn’t you make a stand when you lost CrossCountry?" We lost twice on East Coast Main Line. Our bids were correct on East Coast Main Line. If we had been given it in the proper process on East Coast Main Line, there would be something like 10 million more passengers today. You would have much faster trains and the East Coast would be as good as the West Coast.

We just decided that at some time you have to draw a line in the sand. On this occasion we decided to draw a line in the sand. This particular bid by FirstGroup is absolutely preposterous when you examine it. It is just taking the system for a ride, literally. It is preposterous.

Tony Collins: I would like to add to that. We have not just started to complain about the process. We have had successive meetings with the last three Secretaries of State for Transport.

Chair: You are now going back to before this franchise was being considered. I want to talk about the system and we may well come on to that, but this is about your complaint about this specific franchise.

Q474 Kwasi Kwarteng: Let us say you are going to court. What do you hope to achieve by that? I ask this because you made a distinction between the flawed process. Clearly that is not something for our jurisdiction; it is the court’s jurisdiction. The second point you made was that, internally, the Department wasn’t following its own rules. What do you hope to show in this court case? Let’s say you get what you want and the judge decides in your favour. What do you hope to have achieved through that?

Sir Richard Branson: First of all, we would much rather not go to court. The fact that there are three new Ministers in this Department and that the contracts have been sent back to FirstGroup mean that there are alternatives to us going to court. We have specific issues that we are challenging in the court. One is whether enough security was asked for from FirstGroup for back-ending this enormous payment in the last three years. All our calculations indicate that they should have put up something like £600 million in security. There are some other points like that which we will be asking the court to look at.

Again, we would much rather that the Department for Transport were open and transparent and answered our questions. The fact that they are not answering our questions means that we have to go to court to try and find out more.

Q475 Kwasi Kwarteng: Would anyone else like to comment on that question with regard to the court case and what you hope to achieve?

Martin Griffiths: There are two or three things for me. First of all, the purpose of the judicial review is to ask whether the process and the rules of the process were followed. We have some specific concerns that they weren’t and we would like somebody to go back and look at that. Hopefully, they will agree and the rules will then be applied. You have asked us whether we are just sore losers. You win and lose in business from time to time. Had we lost and the rules were applied properly, we would accept that. Right now, we don’t have the transparency to understand whether the rules were properly applied or not. The second point for me is for the future. These bids cost millions and millions of pounds.

Q476 Chair: How many millions?

Martin Griffiths: This bid cost £14 million-

Sir Richard Branson: -which would be much better spent on the trains.

Martin Griffiths: Absolutely. There is enormous passenger benefit you could get for that.

Q477 Kwasi Kwarteng: How much is the court case going to cost you?

Martin Griffiths: It is not going to cost £14 million but it will cost a significant amount of money. That is the reason why we are not taking the decision to do it lightly. For the future, particularly from Stagecoach’s point of view, understanding the proposition, what we are bidding for and how it is going to be evaluated is going to be fundamental as to whether we would want to bid in the future. For me, I hope that out of this challenge we get greater transparency about the process.

Sir Richard Branson: Virgin would not bid again if the current process exists. We have now spent over £50 million bidding on the two East Coast Main Line bids on which we were runners-up, CrossCountry, on which we were runner-up, and the West Coast Main Line, on which we have come in as runner-up. With the current process, where somebody can effectively get away with murder in the way that they have done this and not worry about quality for the passengers or the staff, we would not bid again.

Q478 Kwasi Kwarteng: Can I sum up? Your position essentially is that you are trying to play a game and you don’t think the rules are right, but you play anyway. Then, once you have played the game, you are complaining about the application of the bad rules.

Sir Richard Branson: No. What we are saying is that the rules themselves were not followed on this occasion.

Q479 Kwasi Kwarteng: But you also said that the rules were bad as well.

Sir Richard Branson: They have a process where they can throw out a bid that is completely ridiculous. FirstGroup’s bid, by throwing in an extra billion or two in the last three years, was completely ridiculous.

Q480 Chair: This is about your judgment, isn’t it? You keep saying that you haven’t had feedback. Have you had any debriefings at all?

Sir Richard Branson: We have read what various Ministers have said in the press. We have seen what FirstGroup have said in their presentations to their shareholders. It is based on as much information as we have been given.

Q481 Chair: Have you had any official feedback from the Department?

Tony Collins: We have had a single-page analysis of the deliverability score and a comparison with the premium payments. That is all we have had.

Sir Richard Branson: That showed that our deliverability was much better than this.

Q482 Julian Sturdy: I want to go back a little bit on the process. I want to be absolutely clear in my mind because at the moment I am not 100% clear on what you are saying about this. Are you saying that the DfT haven’t followed the proper process, or are you saying that the DfT have followed the proper process but have come to the wrong conclusions? One is obviously about the process and the other is about a judgment. I am not 100% clear which line you are going down at the moment. Are you criticising and going after the DfT over the process they have followed or is it about the DfT’s ultimate judgment? You say it should be £600 million on FirstGroup’s capital but they have requested £200 million. That could be seen as a judgment.

Tony Collins: In terms of the judicial review, we believe the DfT haven’t followed their own rules in the process. We have accepted that the process is what it is. The court case is because we don’t believe they have applied the rules of that process correctly.

Martin Griffiths: To take up the point there, in our opinion, based on going through this bid for 18 months and doing all the analysis that we did, there was a set of rules for establishing what the capital structure needed to look like under certain bid assumptions. It wasn’t a judgment; it was formulaic. We would like to understand, based on what we have seen and from the numbers and other material that FirstGroup have given publicly, how we can get back to the numbers that have been given.

Q483 Julian Sturdy: What you are saying is that, if the DfT had gone through the process and the calculations properly, they should not have come up with that £200 million figure but with something in the region of £600 million.

Martin Griffiths: Correct.

Q484 Julian Sturdy: You are saying that those figures haven’t been properly calculated, so it is not about a judgment on that but about the calculation process that they have gone through.

Martin Griffiths: That is correct.

Q485 Iain Stewart: I would like to probe a little more into why you believe the FirstGroup bid is undeliverable. In the financial year to March of this year, Virgin Trains’ passenger turnover increased by 16%. FirstGroup’s bid is based on 10.4%. Why do you believe they are not able to achieve this?

Graham Leech: They have justified the 10.4% figure that they have quoted for the new franchise by talking about the 10.2% that has been achieved in the last 10 years as if that would simply continue. The figure for the last 10 years is artificially inflated because it contains a large amount of traffic that came back to the railway after the engineering work for the upgrade. There were a lot of journeys that would normally have been made in the previous years but could not be because the services weren’t running. That then came back into those figures, so it is artificially inflated.

The correct benchmark is to look at the franchise as a whole and put everything that happened into it, which is 7.9%. That is the benchmark that ought to be used and that is what we used in our bid.

Q486 Iain Stewart: But you achieved 16% last year in a very choppy economic circumstance. Why is it unreasonable to assume that they will make 10%?

Tony Collins: Last year’s performance was taking the benefit of the very high frequency timetable that we put in at the end of 2008. It is bringing in the benefit of that high frequency timetable. It normally takes about two to three years to get the passenger volumes up when you put in a big investment like this.

To contrast last year’s growth, our underlying growth for this current financial year is less than 4%. We have built the timetable benefit up for the very high frequency timetable that was put in at the end of 2008. We have brought the passengers on by bringing them on through price, strategy and so on. Now the franchise is waiting for the next big initiative to keep that growth growing. We have a steady state railway, with no big initiatives this year, and our underlying growth is less than 4%.

Graham Leech: We have great confidence in our forecasting. We are currently in the eight-month extension of the franchise. We did have a much lower revenue forecast for this year, based on the conditions, than the DfT, which turned out to be right. The starkest example is that the DfT were forecasting a £15 million benefit to Virgin Trains from the Olympics when we were negotiating the extension. We always believed that there was going to be a very small net benefit because most people would be put off travelling to London. Spectators would come but normal trips would not take place. As it turned out, the benefit has been £1 million. It comes back to deliverability. The number of passengers that the DfT were forecasting would be carried on Virgin Trains during the Olympics physically could not have been fitted on. It is the same situation that we now have with the FirstGroup bid.

Q487 Iain Stewart: You talk about step changes in capacity of the network and new timetables. I assume that FirstGroup have built those into their forecasts as well. There will be significant population growth in many towns and cities along the route, including my own area of Milton Keynes. There will be new feeder services coming into the West Coast with East West Rail and Northern Hub. It is surely perfectly reasonable to assume that there will still be substantial passenger growth on the network.

Graham Leech: Yes, there will; indeed.

Q488 Iain Stewart: This comes down to a judgment call between what your forecasts say and what FirstGroup’s say. FirstGroup are not a newcomer to the game. They are an experienced railway operator. Surely their forecasts will be underpinned by-

Graham Leech: I would like to confirm that we absolutely believe there is massive potential for further growth on West Coast. We are forecasting growth to 50 million by the end of the new franchise. There is a lot of new capacity available, as FirstGroup have correctly said, from the additional Pendolino vehicles. Of course there is growth through the economy.

There is a common-sense element of saying, "How much will come through the economy and how much will come through the initiatives?" You can also look at it empirically. With the way that things are modelled, you know that if you speed up journeys-where it is 20 minutes faster than it used to be from Manchester to London-that will drive a lot of extra demand or if the service is made more frequent. In the past, we have seen that across the whole of the network. The initiatives that are being proposed by FirstGroup for the new franchise are very small compared with what has happened in the current franchise. Therefore, empirical knowledge, but also pure common sense, tells you that you are not going to get the same level of growth driven by that. Of course there will still be growth through the economy but there is a risk around that, and that takes you back to the risk assessment.

Q489 Kwasi Kwarteng: Talking about risk, what do you think are the most outrageous assumptions in the FirstGroup bid? Is it the GDP growth figure that you have a quibble with or this 10.4% annual increase?

Sir Richard Branson: Both.

Q490 Kwasi Kwarteng: On the risk, would you like to outline for the Committee what you think the doomsday scenario is for the British taxpayer?

Chair: What is the worst thing that you think can happen?

Sir Richard Branson: The doomsday scenario is exactly what happened on the East Coast Main Line. It is the awful disruption of them handing back the keys and the Government having to step in and run it for a while. All the investment that has gone in for the last 15 years into building the West Coast Main Line and making it one of the best networks in the world here in Britain could go to waste. The East Coast is the best example of that. It has been dreadful to see what has happened on the East Coast Main Line in the last couple of years.

Q491 Kwasi Kwarteng: I have one tiny little question. You have said that these assumptions of growth are absurd or difficult to see happening. You are a hugely experienced businessman. Why do you think they made those assumptions in this bid?

Sir Richard Branson: I think they saw the way the current franchise system is run. FirstGroup as a plc have some cash issues. They thought, "Let’s work backwards and bid a small amount of money for the first 10 years, and that will help our cash flow position if we can persuade the Government to accept our bid. Then in the last three or four years let’s put in this enormous figure and hope we get away with it." If you sit down as a Committee and calculate it properly, you will see that they physically can’t get the people on the trains to make that figure. Somehow they have managed to get away with it.

Virgin, who has had 15 years of running this, put in a realistic and sensible bid. We promised to invest far more money than FirstGroup in improvements, infrastructure and new trains. We are going to have a complete Pendolino fleet. FirstGroup are going to have a mixture of fleets and so on. We can take the West Coast Main Line on to the next major stage, with a staff who are committed and excited by the prospects and passengers that like the experience. Obviously we can improve and we have lots of exciting new things to do with it.

Q492 Chair: It is true that in your bid you have made commitments to new services. You have listed Blackpool, Telford, Bolton and Shrewsbury. Are these actual commitments? Would they be in the franchise agreement or are they aspirations?

Sir Richard Branson: Ours are absolute commitments. All our £800 million investments are complete commitments.

Q493 Chair: Legal commitments; franchise commitments.

Sir Richard Branson: I believe legal commitments.

Q494 Chair: It is important that we know, because one of the points you made at the beginning of your comments, Sir Richard, was that Virgin could offer a better service and deliver more for passengers. That is only true if the things that you are saying are going to happen will in fact happen.

Sir Richard Branson: We are making legal commitments.

Q495 Chair: You would be prepared to put these promises into-

Sir Richard Branson: Yes, exactly. One thing that has slightly upset us as the losing bidder-and people have to justify why they have made that decision-is that there has been a lot of talk about FirstGroup adding new this and new that. The truth is that we are going to be adding something like three times what FirstGroup are planning to add in general improvements in different areas.

Q496 Chair: Those would be franchise commitments and not statements.

Sir Richard Branson: Franchise commitments, yes.

Tony Collins: Just to clarify that, on the new services we have to get ORR’s approval to run them like any other operator. If we get the ORR approval to run them, it is a commitment that we will run them.

Chair: Thank you very much for coming and answering our questions.

Examination of Witnesses

Witnesses: Tim O’Toole, Chief Executive, FirstGroup plc, and Vernon Barker, Managing Director, UK Rail Division, FirstGroup plc, gave evidence.

Q497 Chair: Good afternoon, gentlemen. Welcome to the Transport Select Committee. Could we have your name and position, please?

Tim O’Toole: My name is Tim O’Toole. I am the CEO of FirstGroup.

Vernon Barker: My name is Vernon Barker. I am the Managing Director of FirstGroup’s rail division.

Q498 Chair: What assumptions does your bid make about growth in passenger numbers and growth in revenue?

Tim O’Toole: Our belief is that the growth that you have seen over the last 10 years can and should be continued if the Government are going to get the advantage of the extraordinary investment they made in this line. We think that, contrary to Virgin’s depiction of their stewardship in recent years, since they have been in revenue support they have had very little incentive to drive growth on this line. Yet the growth has just come to them. If you apply real yield management and if you put a fare structure in front of people that attracts the public, we have every reason to believe that you can continue to grow at a rate consistent with the previous 10 years.

Indeed, we believe this because we have experienced it on our own railway, TransPennine Express. It has a user base that is almost identical to the West Coast. We have been able to drive fantastic passenger growth there. It is almost a poster child for a successful train operating company. We think that, by bringing those plans and those skills to the West Coast, we can deliver similar growth.

I would also point out that the Government obviously believe it as well as most of the commentariat. The reason why High Speed 2 has to be built is because everyone believes that that growth is there.

Q499 Chair: What about increasing fare revenue? Is it right that you are proposing to increase average fares by about 22%? That seems to be in your bid.

Tim O’Toole: The commitment we have made in our bid is, first, to create a more sensible fare structure. The first step out of the blocks is that we are going to reduce the Standard Anytime fares by 15% within the first two years.

Q500 Chair: You say you would, but is that going to be a contractual commitment within the franchise?

Tim O’Toole: Absolutely. We say within the first two years but it will happen in about 13 months. We will do it coincident with the regulated fare changes. The assumptions on fare increases over time in the bid simply assume a certain level of RPI and the like. If that isn’t there, it is all right with us because our premium is lower. That is just the mathematics of putting together the bid.

Q501 Chair: What about the figure of 22% increase in average fares? That is in your bid, isn’t it?

Tim O’Toole: I don’t recognise that at all.

Vernon Barker: I don’t recognise the number. The reduction in the Standard Anytime fare is 15%. That affects 20% of the fares starting in January 2013. That will be delivered within two years. Thereafter our fare increases will follow very similarly the way they have done previously. Regulated fares, of which there are about 37% in the fare base, will be governed by the regulations-RPI plus 1% or plus whatever. The rest will be subject to market pricing.

Q502 Chair: What does that mean? What is the increase going to be in non-regulated fares?

Vernon Barker: I don’t recognise the statistic of 22%. It is not a number we have put in our bid. I think it is a number that someone else has calculated.

Q503 Chair: Is it a wrong calculation?

Vernon Barker: It is not a number that I recognise.

Q504 Chair: What calculation would be a correct one? What number would you recognise?

Vernon Barker: I think our fare increases are going to go up broadly in line with inflation.

Q505 Chair: What about increases for non-regulated fares-fares which are discounted now and advance fares? What plans do you have for those?

Vernon Barker: Our intention is to grow by volume, so I think that is clouding the average fare. The issue isn’t so much what an individual fare will increase by because we are going to better space the steps between the lower fare and the higher fare. The higher fares are very expensive at the moment. You will see them moving together so that you get more of a graduated fares increase. I don’t think the 22% is a number that can be used.

Q506 Chair: Let me be quite clear. What are you saying about increases in unregulated fares? Are you saying they would only be at inflation?

Tim O’Toole: No. We are saying they would probably follow inflation. That is our assumption. Over the term they would move where other fares had moved. The point that Vernon is trying to make is this. We expect to offer additional options for people. You have heard in some other reports in the press that we have hinted at the fact that we are going to put in another class of fares. We expect to make a compelling enough offer that some people will choose another pricing point. They will pay up for services. They might not, today, be willing to pay to go up to first class, but they might go to an intermediate class. Say they wanted to do work but they didn’t care so much about some other element of the trip; they just wanted space. We have made certain assumptions about the effectiveness of putting in those kinds of offers. For your purposes that would look like a fare increase, but in fact it will be a choice people make. We will have to make it attractive enough for them to make that choice.

Q507 Chair: So what looks like a fare increase might actually be an attractive-

Tim O’Toole: It is another option.

Q508 Kwasi Kwarteng: What do you say to the accusation that your bid relied heavily on future growth rates that, at the present time, seem very optimistic? The accusation is that for the first eight years you are not really offering that much more than the other competitor, but you have back-ended a lot of the fruit, if you like, on slightly inflated projections. On that basis it is said that you won the bid. What do you say to that?

Tim O’Toole: That allegation-made by Virgin, I understand, and not by you-is flat out wrong. It is just another bad guess they have made about our bid because they actually haven’t seen our bid. If this bid were back-end loaded, you would have a bid with much higher growth rates at the end so that we can justify some giant premium. That hasn’t happened. In fact it is very different from that. It is a much smoother line with lower growth rates at the back end. The only reason the numbers are larger at the back end is because of compounding. The growth rates are lower at the back end, of course, which is the sensible thing anyone would assume.

Q509 Kwasi Kwarteng: What about the risk in this scenario? Clearly you have quite aggressive projected growth figures. The last 10 years, until about four years ago, were very prosperous. We were growing at between 2% and 3% a year as a GDP in the economy. The next 10 years will perhaps not be as economically favourable. There is some downside in your predictions. Are you going to be covered on the downside?

Tim O’Toole: By definition, the Government have assessed that. They have assessed the deliverability. As you have pointed out, they have put this £200 million subordinated loan guarantee requirement in for us where it doesn’t exist for the others. That is the handicapping difference they see.

The description that some people are making about our bid would lead one to believe that we have these crazy numbers and everyone else’s are at some sober level. In fact, as you have put it, ours and Virgin’s bid in the absolute number of pounds involved are very similar through almost all of the term. The difference is that at the back end they assume it just flatlines, shuts down and can’t grow any more. The last three years are dead time to them. We assume that with continued investment you could continue to grow. The reason why we would make that assumption is that, even in a railway that hasn’t been rebuilt and that is stuffed to the gills like First Great Western, we are seeing growth rates at 8% in the past year. If you continue to provide a good service, you will continue to grow. We think we can continue to grow right into High Speed 2.

Q510 Kwasi Kwarteng: A lot of the debate has surrounded this £200 million figure as an insurance cushion. The suggestion has been made that this £200 million is too small given the risks involved in your bid. What would you say to that? We heard earlier that a figure of £600 million might be more appropriate.

Tim O’Toole: We think we understand how Virgin tried to back-engineer and get to the £600 million. We understand the formula. We believe they have used the wrong inputs because, when we do it, we get to the same number that the Department got to. I think the problem is simply that they don’t understand our model because they haven’t seen it.

Q511 Chair: Is it true that you have a cash problem and you might indeed decide to walk away when you get to 2020 or 2021? It is a long time ahead, isn’t it? You may not even be in the company then.

Tim O’Toole: No CEO who sits in front of you could make a representation that they would be here 15 years hence. That is not peculiar to FirstGroup-that is the first point to make. Secondly, we are long-time players in this business. We have been in the rail business for a long time. I would like to think we are very good at it and it is part of our business. No business that cares about their reputation, where this is a core part of it, would so cynically manipulate the process such that they would throw away their prospects of continuing to be in the business longer term. Our board would never have done that.

Q512 Chair: Do you have a cash problem? You didn’t answer that question.

Tim O’Toole: No, we don’t have a cash problem. We have steadily paid down our debt ever since the Laidlaw acquisition. This year we have pointed out that cash would be flat, but we believe that, as our bus businesses in the US and here continue their positive turnaround, cash flows will return to what they were.

Q513 Mr Leech: You said to Mr Kwarteng that you don’t accept Virgin’s analysis that it should be £600 million rather than £200 million but you calculated the same amount as the Department. Does that mean you accept that your bid is five times riskier than Virgin’s bid?

Tim O’Toole: I can just tell you that we are offering to do more, provide more services and to pay the Government more money. It stands to reason that, in any kind of adjustment mechanism where you are trying to cover the Government’s risks, you would attach a higher figure to us. It is common sense.

Q514 Mr Leech: With respect, that is the sort of answer I would have expected from a politician rather than a chief executive officer. I actually asked whether you accepted that your bid was five times more risky than Virgin’s.

Chair: Mr Barker, is it five times more risky?

Vernon Barker: No, not at all.

Q515 Chair: Then why are you being asked for five times as much?

Vernon Barker: We are only being asked for five times the amount on a subordinated loan facility. The intention of a subordinated loan facility backed by a bank guarantee is to maintain a solvency requirement during the course of the full 13 years. It is the top-up or a maximum exposure that either of the two bids may experience at any one point during that 13-year life. It is not that it is five times more risky at all; it is just the amount you need to maintain and achieve the Department’s test to pass the solvency requirement.

Q516 Mr Leech: Do you accept that your bid is riskier than Virgin’s?

Vernon Barker: Not when we have presented a subordinated loan facility and the risk premium-if you want to call it that-or the bonding to achieve the higher premium; not at all.

Tim O’Toole: Just to be straight-

Q517 Chair: Before that, the purpose of that requirement for you is because the Department are assessing a higher risk. Is their assessment right? I am not talking now about what would be appropriate for you to meet that risk. It is about whether you have a five times higher risk than Virgin. Do you accept that that is the case?

Tim O’Toole: We have not seen Virgin’s model. We have not seen the Department’s calculation. We can’t be an apologist for that calculation and then compare it to ours. Let me say this. I would concede that, since we are committing to continue to grow the railway throughout its life and they are committing to just flatline for three years, we are taking on more. If you are taking on more and it is taking on risk, then it is more risk.

Q518 Kwasi Kwarteng: As a matter of common sense, if someone asks for a guarantee in terms of insurance, if you like, of £200 million of one customer, and for pretty much the same services asks £40 million of the other, as a businessman you would probably appreciate that one risk was appreciably greater in the first instance than for the second. Just from a common-sense point of view, why would the Department ask you for a £200 million subordinated loan, as you put it, and only £40 million from Virgin?

Tim O’Toole: If they were here I am confident they would say they did view more risk in this bid, but in choosing the bid they have to opine that it is deliverable. Contrary to all the things you heard from Virgin about their advantage on deliverability, the deliverability scores on these two bids was very close. We saw very little difference. It was 64 to 60.

Q519 Mr Leech: What do you see as the percentage chance of you handing the keys back before the end of the franchise?

Tim O’Toole: I don’t see any chance of our handing them back because it would destroy our ability to continue to run a rail business in this country.

Q520 Mr Leech: When the East Coast was returned to the Government, a lot of arguments were made that they should lose all their franchises and shouldn’t get any franchises in the future. Would you agree with that assessment? Would you say that, if you handed the keys back, it would be appropriate that FirstGroup didn’t get future franchises and lost the ones that they currently have?

Tim O’Toole: As a practical matter that would be what you would face. I personally didn’t agree with those views of National Express. They are obviously doing a very good job on c2c, so why would you want to disturb that operation just to spite the other?

Q521 Mr Leech: But, if there is no chance whatsoever that you are going to return the keys, you could make the commitment, couldn’t you, that you would return all your franchises to the Government if you were unable to deliver on this one?

Tim O’Toole: But that is Government policy that imposes a cost on the businesses. You would price them accordingly, wouldn’t you? It would be up to the Government to decide if that was a requirement.

Q522 Mr Leech: If you don’t accept that you could make that commitment, even though there is no chance of returning a franchise, would it be conceivable that someone in your position as a chief executive officer, if you were still in charge at the end of the franchise, or someone who was head of your rail business would stay in their job if they returned the keys before the end of the franchise?

Tim O’Toole: I am sorry; I am not sure I am following this. Do you mean should the shareholders get rid of a CEO who returned the keys?

Q523 Chair: If a chief executive did that, would they stay in their job?

Tim O’Toole: Assuming the reason for doing it was a failure on the chief executive’s part, yes.

Q524 Mr Leech: I am just trying to assess what the real risk is to your franchise. If there is effectively no risk to your franchise and there is no chance that you are not going to deliver on the whole of the franchise, why are you so coy about whether or not you would keep your other rail franchises or your job, or your successor would keep their job, if there is no risk to your bid?

Tim O’Toole: I don’t mean to be coy. I also don’t mean to be giving the impression that our view is that this is simple, in the bag and that there is nothing for us to do here. This will require a lot of hard work. It is the kind of hard work we have delivered in other places such as TPE.

Q525 Mr Leech: You do a good job there.

Tim O’Toole: There is always risk involved with that. We just think that we are going to be able to handle that risk.

Q526 Chair: It is a long franchise, isn’t it? That is the nature of it. It could be 13 years or it could be 15 years. It is really quite easy to make commitments for the future that might be a long way off, isn’t it?

Tim O’Toole: We have no choice. That is the structure. We have to make commitments over 15 years if we are bidding for it

Q527 Chair: If there is that risk there and it may be five times the risk of Virgin-it may be-perhaps it doesn’t trouble you too much to say that there isn’t really any risk.

Tim O’Toole: Whether it is more risk than Virgin’s or more risk than the other two bidders, who aren’t even mentioned in here, doesn’t matter to me. All that matters to me is whether my bid works, and we have put the study and analysis behind it that gives us confidence that we can deliver it.

Q528 Kwasi Kwarteng: You will appreciate the fact that we are a Committee of the House of Commons and we have some responsibility for taxpayers’ money. It might not matter to you in terms of the risk, but it certainly matters to the Government, the taxpayers and our constituents. That is why we want to bear down and understand this element of risk. From what you have said, your bid is riskier than Virgin’s bid. You can deal with those risks and you might have provision with things like the £200 million bond for those risks, but what you are saying is that there is more inherent risk in your bid than in the Virgin bid.

Tim O’Toole: When the Government do any of these procurements they obviously assess what return they can get at what level of risk. The easiest thing to do would be for a Government, if all they cared about was risk, to take the lowest bid. Then we, the private operators, could put our feet up, do nothing and get paid.

Q529 Chair: But this isn’t the question being put to you. We are asking you to accept clearly that there is a risk here and the risk is higher-

Tim O’Toole: Absolutely there is a risk. There is a risk in any business venture of this kind.

Q530 Julian Sturdy: I want to continue on the risk side of things. As a number of members of the Committee have made clear, this process we are going through today is very important to us. The DfT explained that your bid should be supported by £10 million of shareholder capital, a £45 million performance bond and this £190 million subordinated loan, which we have already discussed. Within the process, is it correct that that £190 million subordinated loan is only guaranteed for three years at the moment?

Tim O’Toole: It is underwritten for three years by the bank because that is the term the banks will write for.

Q531 Julian Sturdy: Can you talk me through the process after those three years? Are you confident that you will be able to secure that £190 million right the way through?

Tim O’Toole: Six months before the expiration of that we have to have renewed it. If we don’t, then the Government can call on their guarantee. If we are unable to renew it because of some banking crisis-

Q532 Kwasi Kwarteng: It is a revolving credit.

Tim O’Toole: Yes. We would have to put in cash of that amount.

Q533 Julian Sturdy: So you don’t feel that that is a risk then. Whenever that is reviewed, there is no concern from you about there being a risk at that point.

Tim O’Toole: No, because we have over £800 million of headroom as it is. If for some reason in the banking industry that I don’t understand those facilities weren’t available, we would obviously just draw down on our headroom and put cash in until such time as those kinds of bank guarantees were available.

Q534 Julian Sturdy: Do you think the risk assessment process has been fair?

Tim O’Toole: From our perspective, yes. We have no reason to suspect otherwise.

Q535 Chair: What kind of debriefing have you had from the Department?

Vernon Barker: Like Virgin, we get a letter from the Department for Transport that gives some very brief details. In respect of bidders that don’t win, they will get a comparison of their premium against our premium-the scores on the 10 deliverability plans against ours-whereas we will just get a win letter. They will get a comparison on the funding as well. They will see all those three areas. We will not have a comparison of our scores with those of other bidders but we will obviously just get a very short letter saying, "You have won; your funding requirement is X and your deliverability scores were these 10 numbers."

Q536 Chair: Was there a point during the assessment process where you were called in to discuss the nature of the risk and before the decision was made about what financial provision you would be required to make?

Vernon Barker: If I understand the question correctly, we respond to the invitation to tender and we present our bid. We put in a certain level of funding requirement at our own behest in terms of the risk that we see within the bid to meet the Department for Transport’s solvency tests. The Department for Transport would then come back to us, as they did after we had submitted our bid, to say that they felt the solvency requirements should be "Y’" and would we put that amount of money in, hence the reason it was £200 million. We say yes and then we move on to the chosen bidder-

Q537 Chair: What kind of discussion took place at that point and when did that happen?

Vernon Barker: That would have happened a few weeks before the award. The discussion was that their assessment of risk differed from ours, which probably isn’t surprising. We have a very confident view of all of the different delivery plans that we are intending to do. They have a slightly more cautious one, which you would perhaps expect them to take. They sought some higher level of funding. They moved it up to the £200 million, past where we had already predicted it was required. We feel that it doesn’t need the £200 million but we were prepared to move there. There was a very short discussion, "Will you present further insurance"-I think that was the term used earlier-to cover our concerns?" We said yes and then we moved on to the next stage.

Q538 Chair: Was there a negotiation before you reached that figure?

Vernon Barker: Not with the Department, no. It was, "Will you meet this figure?"

Q539 Chair: It was yes or no, or was there some discussion about it?

Tim O’Toole: There can be a negotiation.

Q540 Chair: But was there?

Tim O’Toole: In this case, the negotiation was primarily internal. It was our deciding.

Vernon Barker: There wasn’t so much negotiation as clarification of the requirement and the level needed. Once we had helped them understand our numbers better, their level of funding actually came down.

Q541 Chair: So in the course of your discussion at this point the requirement from the Department was reduced; is that right?

Tim O’Toole: Just marginally. It was a very small amount.

Q542 Chair: It was reduced by how much?

Vernon Barker: Only £15 million, I think; a very small amount.

Q543 Chair: It was reduced by £15 million as a result of your discussion with them.

Vernon Barker: Yes.

Q544 Kwasi Kwarteng: I want to ask something quickly in terms of what happened to the East Coast Main Line. A key element of Virgin’s case is that this has happened before in that we had bidders who had made quite outrageous and extravagant claims. They won bids and then they failed to deliver. I just want to know your comments about those particular instances where the keys were handed back.

Tim O’Toole: I think the most outrageous thing is the history that Virgin is presenting to you. What happened in East Coast the second time with National Express was that they put in a bid that obviously failed when they were hit by the recession and, most importantly, there was no cap and collar to come in for the first five years so they got caught in that trap. If the Government, for whatever reason, had chosen not to take National Express’s bid and had given it to the second place bidder, which in this case was Virgin, they would have got crushed; they would have defaulted exactly like National Express did. When you look at the growth rate numbers and you look at what happened in the economy in the next four years, there is no way they could have done anything otherwise. This kind of depiction that they are the voice of sobriety through this history just doesn’t square with the facts.

Q545 Iain Stewart: In the criticism of the deliverability of your bid, Virgin claimed that you will require unprecedented seat occupancy levels. They go as far as to say that, towards the end of the franchise, every seat on every train every day needs to be filled, otherwise the franchise goes bust. Is that true?

Tim O’Toole: No; it isn’t true. What our bid does require is that we move the modal share on this railway to a level that is comparable to other main corridors. Quite oddly, it is a modal share that is low in rail for the West Coast Main Line. It also requires that the seat occupancy percentages are moved up closer to what we have on our other railways. It is another 10 points higher than they have and which we enjoy on Great Western, and up to 50% on TPE.

Q546 Chair: What percentage?

Tim O’Toole: They are around 35%. We are in the mid-40% on Great Western and we are at 50% on TPE.

Q547 Chair: What are you assuming for West Coast Main Line?

Tim O’Toole: We are assuming that with West Coast we will drive those occupancy rates up into that territory of between 45% and 50%. The way you do that is by attracting people to the off-peak services. That is what Vernon has been so successful in at TPE. Towards the end of the franchise, as these plans are successful, if we need to add capacity, we are committed to doing just that. We have not made any kind of silly assumption that every seat on every train at all times of day has to be filled.

Q548 Iain Stewart: Can I just probe you when you say you will add capacity if necessary? What capacity do you mean, because that line is pretty much full? There is not much else you can do by way of lengthening trains or adding in additional services. That is the whole rationale for High Speed 2. If you get to the last four years or so and you have been very successful in growing the business, are we going to see trains that are completely packed and severely overcrowded?

Vernon Barker: I can help with that. The situation in terms of rolling stock and seats with which Virgin have tried to make the comparison is the Pendolino fleet that they talk about. Our bid includes us introducing an extra 11 six-car trains, which is incremental to the position that they would be at today. We are doing just that. We are lengthening five-car trains that run to Scotland to six-car trains and we are introducing more of them. There will be 66 extra vehicles, so there is a step-up on capacity to keep pace with our ambition to drive ridership.

We have more costs continuing through the franchise to support initiatives like yield management, marketing and customer service. As Virgin haven’t seen our bid, I think they have drawn you to the suggestion that there is only £350 million-worth of investment. If they read the detail correctly, that is £350 million in the first five years. Our investment in customer service continues throughout the life of the franchise to do just that-to support growth which is at the same rate throughout the franchise.

Q549 Iain Stewart: Forgive me; I still come back to the capacity increase at the end of it. The new trains and the cascade effect will happen towards the front of the franchise. What happens if you have been successful and you have hit your targets? Are we still going to get to a point towards the end where there is nothing else you can do in terms of increasing capacity?

Tim O’Toole: We could do a couple of things. We could add some trains. Depending on what the demands of the public were, we could convert first class to a different class. There are many different things you can do, but if you are asking whether the line in the last two years or so will be crowded compared with what it is today, the answer is almost certainly yes. That is why High Speed 2 will have to be built.

Q550 Chair: In your bid, and again repeated, you talk about additional trains and services, but will they be part of the franchise part of the contractual agreement or just something that you say you will do?

Tim O’Toole: Yes. The only caveat is the same one that Tony gave you. With some of these new services you do need ORR’s approval, but we certainly think there is a compelling case and we are confident we could get it.

Q551 Chair: So you are saying that your intention is that all of the new services that you have spoken about as desirable will be part of a contractual agreement in the franchise. Is that what you are saying?

Vernon Barker: Yes.

Tim O’Toole: Yes.

Q552 Chair: You are quite clear on that; with the years that they would be introduced written into the contract.

Vernon Barker: Yes. They are a commitment that we have offered and given, and we are waiting to see them accepted and signed.

Q553 Chair: Is your understanding that the Department makes its assessment by comparing the base specification-what it has asked for-and then looks at what is desirable and the additions that you are offering separately? Is that your understanding of the process?

Vernon Barker: The base timetable specification was presented to us. We have offered these additional services, as I understand other bidders have done. They are included in our base bid.

Q554 Chair: So everything that has been stated as coming from you in terms of new services and new rolling stock would be a contractual commitment and not an aspiration. Is that correct?

Tim O’Toole: That is correct.

Vernon Barker: Yes, it is.

Q555 Julie Hilling: I want to carry on with the passenger experience bit that is going to come out at the end of this in terms of space. You talk about refurbishing the Pendolinos and the Voyagers. Are you going to be putting more seats on those current trains? We have additional carriages that are being inserted as we speak anyhow, so we know that the lengthening of the trains is happening in terms of catering and so on. What are the changes going to be that allow more people to get on those trains now?

Tim O’Toole: We are not adding more seats in the carriages. If you are wondering if we are going to make everybody cramped, then no. The way more people will get on those trains will be because there are two more carriages, so nine-car trains become 11. That is what will drive it. We just want to refresh the interiors. Though the trains are relatively new and beautiful, the interiors are worn.

The other thing we are going to do is try to provide the amenities that we think really matter to people these days. For example, wi-fi will be free for everyone and not restricted in the way it is now. We are going to have improved reception for mobiles on the trains. We are going to have an improved catering offer. In addition to the stores that are there, we are adding in-seat catering because our studies have shown that a lot of people prefer that. They don’t want to leave their luggage and have to get food somewhere, because they are uncomfortable with that situation.

Over the longer term, the most meaningful thing we will be doing is using new means of communicating with people so that they can understand what the best offers are for them and can take advantage of them. That will also help us put in targeted offers to people to help drive these volume increases. We want the whole experience for the passenger to be one that they feel they own and dictate. They tell us what amenities they want, which is one of the reasons why we want to offer more classes of service so that they have an election to make.

Q556 Julie Hilling: Coming back to the classes of service, I got a bit confused when you were answering the Chair’s questions about what fares would be going forward. Will the anytime-except-peak ticket still cost £73?

Tim O’Toole: Absolutely.

Q557 Julie Hilling: This is for the off-peak walk-on. Is that going to be the same price going forward and is it going to be available at the same time periods?

Tim O’Toole: Yes. What we are talking about is adding more pricing points. As I have said to some people who ask, "What does that mean?", think of what Eurostar has done. By adding a class in between first class and standard, they have given people an opportunity to buy up because they are looking for those amenities but they don’t want to pay the whole fare of first class. That is what we are talking about. We are talking about adding more pricing points to help drive volume.

Q558 Julie Hilling: Will the current fare structures be the same in terms of when it is peak, when it is off-peak and the ability to buy those tickets?

Vernon Barker: The fare structures remain the same in terms of Anytime products, off-peak products and the advance purchase products. The structure of fares stays the same.

Q559 Julie Hilling: I have another question on staffing because clearly great concern has been raised that you will be denuding the West Coast of its staff. What is your commitment in terms of staffing levels as they exist now-on-board and station staff?

Tim O’Toole: As we have said, our bid and our model assumes that staffing levels are probably the same for at least the first five years.

Q560 Chair: And after five years.

Tim O’Toole: It is very difficult to predict exactly how you are going to deploy everyone in a time frame longer than that. We have to see, for example, how revenue collection goes and how people buy their tickets over time. The world changes and we will be adapting.

Our plan is based on growth. The only way you can grow is if you have the people out there doing the things that people want to see, otherwise they are not going to come to you. It isn’t an option for us to cut, cut and cut. There is no way that things that the head of Virgin said we are going to do could possibly work or could ever be part of our plan. This is all about growing revenue, so we need the employees if we are ever going to do that.

Q561 Mr Leech: I am intrigued by something you said before. I think you said that one of the ways in which you were going to grow passenger numbers was by managing demand and getting extra customers on the quieter trains. Is that right? That seems to be completely at odds with your plans to reduce Standard Anytime ticket prices because that does completely the opposite. Surely if you want to manage demand and you want to fill the less busy trains, you should be reducing your advance purchase ticket costs rather than your Standard Anytime costs. Why particularly do you want to do that and increase costs for advance purchase ones?

Vernon Barker: There are two reasons for doing that. The first is that the Anytime product can be used in the peak. There are certain peak trains that are not as full as trains available immediately after the peak. We would wish to encourage more people that wait for the services immediately after to travel within the peak.

The other thing that is probably more presentational is when you do the research-and we have commissioned independent research-on the price perception of fares in the UK and price perception on the West Coast Main Line, because some of the fares for the Standard Anytime products are relatively expensive at just short of £300 for a standard return fare to Manchester; it is the one that most commonly gets quoted. Most non-users of rail-and this goes back to the story of growth-recognise or believe that the price is anywhere between 40% and 80% higher than it really is. There is a value in reducing that so that you stimulate more awareness and more people to your railway.

Q562 Mr Leech: I don’t want to put words into your mouth, but are you saying that this is in fact just a headline-grabbing figure? You are going to reduce Standard Anytime prices by 15%, but actually most people will see an increase because all those people that currently get the £39.50 first-class advance ticket from Manchester to London won’t be able to get that any more?

Vernon Barker: No; quite the reverse. It is so that people can, when they choose to walk up to the station, get a more affordable fare.

Q563 Mr Leech: How many people do that, though? How many people physically go to the train station and buy the full-price ticket? What proportion of passengers does that?

Vernon Barker: It is about 21%.

Q564 Chair: Will the cheaper tickets still be available?

Tim O’Toole: Yes.

Q565 Chair: Categorically yes?

Tim O’Toole: Yes. The person who wants to buy the ticket you were referring to could still buy that ticket.

Q566 Mr Leech: And those prices aren’t going to be affected by-

Tim O’Toole: Those prices, as we said about prices generally, will-

Q567 Mr Leech: They will just go up by inflation.

Tim O’Toole: Right.

Q568 Chair: And that is a commitment.

Tim O’Toole: That is an assumption.

Q569 Chair: It is an assumption.

Tim O’Toole: Well, there aren’t any commitments on absolute price increases in future years.

Q570 Chair: Let me just clarify this. What are you saying about price increases in future years? You are assuming; you are not making a commitment.

Tim O’Toole: We can’t just move prices any way we want because there is an elasticity of price and you pay for that. In order to support this level of growth, we assume that prices will increase at about the rate of inflation.

Q571 Chair: You assume.

Tim O’Toole: Yes; that is what we think will be required. We don’t think that the market would take much more than that.

Q572 Mr Leech: Have you had any discussions with the Department about changing what the peak hours are?

Vernon Barker: No.

Q573 Mr Leech: So you wouldn’t be looking to change what the peak hours are.

Vernon Barker: We have not had any discussions. It is not part of our plans, no.

Q574 Chair: But you could have thoughts about that.

Vernon Barker: We might do now.

Q575 Chair: You do have.

Vernon Barker: No; we don’t.

Q576 Chair: What are your thoughts about changing the peak hours?

Vernon Barker: Our thoughts on the peak hour service, if it is the services immediately after the peak where they are quite busy coming out of Euston, are making them more affordable advance purchase fares in the peak to encourage people to move into that, as much as the Standard Anytime fare reduction.

Q577 Chair: Are you thinking of changing the definition of what constitutes peak hours?

Vernon Barker: No.

Q578 Chair: Virgin say they are going to launch regular daily flights between Manchester and Heathrow from March. How will that affect your growth figures?

Tim O’Toole: I don’t think it will. If you provide a good train service on distances of that length, the studies prove all over the world that rail will trump air every time.

Vernon Barker: I could perhaps add to that. In 2007, FirstGroup with TransPennine took over services that were already operated by Virgin north of Manchester to Glasgow and Edinburgh. In the four years following on from that, when we started with air competition at 50 flights a day, we managed to grow the income from that service by 236%. That was on a railway that was already up and running and we competed head-to-head with air services. We still managed to grow rail along the route.

Chair: Thank you very much for coming and answering our questions.

Prepared 17th September 2012