The premise behind franchising was that competition would increase efficiency, reduce the taxpayer subsidy, lower fares and improve services. While franchising has facilitated passenger growth and service improvements, it is clear that it has not yielded all the competitive benefits initially envisaged by the Government in the early 1990s. Many metrics of performance are plateauing and the passenger is not receiving value for money.
Franchising delivers the most benefits to passengers where there is robust competition between bidders to operate services. Direct awards and the recent fall in market interest demonstrates that genuine competition has been restricted to a limited number of franchises. The core policy objective of promoting competition is not being met and the potential benefits from this model are therefore not being maximised by the Department.
While not a complete alternative to franchising because of fragmentation risks, open access could provide opportunities for new entrants to the market to promote greater competition on intercity long distance routes. This model of passenger operation has been a success in Britain. Any expanded role on the network should occur in a measured way in order to fully understand future operational risks. Prior to any expansion, reform is urgently required to equalise the current track charging structures, which create an uneven playing field between open access and franchised operators. We recommend the Department and Office of Rail and Road work together, as part of the Periodic Review 2018, on a comprehensive set of reforms of track access charges in order to manage the differing requirements of open access operators and franchisees and ensure that operators, taxpayers and passengers get a fair deal. A specific proposal for a public service obligation levy should be put out to consultation by the Department over the next 12 months, so that a new regime can be introduced from April 2019.
The transfer of financial risk to the private sector was another central premise of rail franchising. It is clear that there has been a relatively low level of financial risk from operating a passenger rail franchise. Much of the financial risk in rail has always resulted from maintaining and enhancing the infrastructure and this is still the case. There are wider, whole-of-industry issues related to this, which go beyond the scope of this inquiry. These will be addressed in further detail in our forthcoming Rail Governance and Finance inquiry.
The current structure of franchises limits the ability of the private operator to deliver on the core policy objective of driving efficiencies and delivering benefits for passengers. Specifically, the general size of current franchises does not provide a clear enough market focus for the operator; and the relatively short length of franchises reduces the incentive of operators to both invest and drive down costs. While we acknowledge that there can be no single “template” of what a franchise should look like—as the rail network and passenger needs are diverse—there is merit broadly in procuring longer and smaller franchises. Immediate widespread reform is neither practical nor feasible. Where a franchise is due to expire the Government should, as a matter of routine, review the franchise contracts it lets so that they present less risk to the taxpayer, are not unnecessarily complex, and are focused on the market they serve.
It is clear that that the relationship between Network Rail and operators is not as coordinated as it should be. This is at the detriment of the passenger through higher fares and continued network underperformance. A number of reasons are to blame for this. In particular, the misalignment between the control periods and franchising schedules is a fundamental flaw of the current system and undermines further alignment between Network Rail and train operating companies. We have identified a number of wider issues during our inquiry; we intend to address those related to the regulatory incentives and governance structures in our Rail Governance and Finance inquiry expected to start in 2017.
The Department has an important role in managing the franchising programme which can influence the extent to which franchising can deliver for the passenger. We are encouraged by some of the work the Department has done to improve its franchising operations since 2012. But we remain concerned about a number of serious shortcomings with its capability and capacity. Certain functions of franchising may be better placed elsewhere. We recommend that the Department commission an independent review of its franchising functions. This should address the question of transferring franchise monitoring and enforcement functions to the ORR. The review should also set out a future strategic direction for franchising, including the way franchises are structured and planned for over the longer term and how open access fits into this picture.
The Department has failed to take responsibility for some of the failings in the handling of the Thameslink, Southern and Great Northern franchise. All parties are accountable for the disastrous outcomes on this franchise. While we do acknowledge that factors were beyond the control of the Department, including the significant and inevitable impact of the Thameslink programme enhancements, and industrial relations disputes; the Department does need to address issues such as inadequate planning, inaccurate assumptions and weak performance incentives. We have also exposed serious deficiencies in the Department’s monitoring and enforcement of this franchise. This exposure led directly to the Department changing its policy on performance reporting which is a step in the right direction to holding serially underperforming operators like GTR to proper public account.
Additionally, the use of a management contract for this franchise, where the Department receives fares income and the operator receives a fee for running services, exposes the Department financially. The net revenue losses for the latest financial year, which amount to at least £38 million, will be met by public funds. We believe that serious lessons need to be learned from the GTR issue to prevent similar problems happening in the future when the awarding of a new franchise coincides with a major infrastructure improvement project, the introduction of new technology or the possibility of industrial relations problems.
If GTR is officially found to be in breach of its contract, the Department should consider restructuring the franchise and determine who is best placed to operate it. Ultimately any potential restructure should rectify the contractual shortcomings of the current franchise, realigning the incentives and focus of the operator back to the passenger and reducing the financial exposure of the taxpayer.
2 February 2017