Rail franchising Contents

6Franchising and Network Rail

69.Train operators, who pay for the right to use the tracks, are the client of Network Rail (NR). In addition to coordinating through franchise planning and day-to-day management, this relationship is formalised by a complex set of charges, incentives and outputs determined predominantly by the ORR every five years through its period review. These mechanisms are important in rectifying issues when infrastructure enhancements take place;133 and are also used to hold both NR and the operator accountable in the case of poor performance from either party.

70.It is clear from the trajectory of costs and performance for both NR134 and TOCs in recent years135 that this relationship is not being optimised. This is to the detriment of passengers who pay higher fares and suffer from network underperformance. With infrastructure works presenting the biggest threat to rail passenger performance in the coming years, it is critical that this relationship is improved.136

71.This section of the report examines the core reasons why the relationship between NR and TOCs is not being optimised, and identifies some of the issues we intend to return to in our future Rail Governance and Finance inquiry.

Franchising and the control periods

72.Franchises are procured for a period of between 7 and 15 years in line with a schedule set out by the Department. There is no alignment with NR’s programme of renewals and enhancements, which is managed in consistent five yearly cycles (Control Periods or ‘CPs’, set as part of the Periodic Review), with the current CP5 extending from 2014 to 2019. This was highlighted as a key failing of the current system.137 The key problems stemming from this misalignment are identified below, most of which were identified in the Shaw Report on the future shape and financing of Network Rail published in March 2016.138

a)Outputs and targets for NR and operators: NR is required to meet a series of regulatory targets and outputs set by the ORR. Operationally, a TOCs’ targets are set by the Department within the franchise agreements. Witnesses criticised the lack of alignment between the targets set by the ORR for NR and those set by the Department for operators.139 For example, the current regime has inconsistent performance targets for NR and train operators.140 NR have stated that misalignment worsens as franchises come to an end. This is because the regulatory outputs, as set in the Periodic Review, may be inconsistent with future franchise commitments, or with operators’ commercial decisions.141 NR, in response to the ORR’s initial consultation for the 2018 Periodic Review (PR18),142 felt that “this area requires significant reform in PR18 to align our targets and priorities much more closely with those of local train operators, route-by-route.”143

b)Franchise planning and funding: The determination of infrastructure improvements and the associated funding allocation, through the control period process, is separate from franchising and bid development. Tim Shoveller, Managing Director of Stagecoach, felt that improvements were required to address this disconnect.144 In investigating the East Anglia franchise, it became clear that prospective franchisees were constrained in developing their bids because of uncommitted NR funding. Jamie Burles of Greater Anglia said that all franchise planning has to be conducted on the basis of no additional funding beyond the existing control period.145 This lack of guaranteed funding for NR’s infrastructure works presents the biggest risk to Greater Anglia in delivering journey time improvements. Balfour Beatty commented that a greater certainty of the work and funding that will come forward was required from NR. This was consistent with the conclusions of the Bowe Review and HMT productivity plan.146 Balfour Beatty added that five-year control periods were too short to provide the certainty required by industry.147

c)Franchise changeovers: As franchises are let, operational outputs are specified by the Department, which may include changes to the previous timetable. NR, in their CP5 performance plan, said that there are risks from significant levels of timetable change that typically accompany multiple franchise changeovers.148 Specifically, new timetables may provide for increased route utilisation and reduced journey times which, from NR’s perspective, can reduce the available time for engineering access.149 Responsibility for any subsequent underperformance of the infrastructure against the new timetable will then be allocated to NR—even though there may be restraints on their capacity to address problems because of a fixed resource allocation for the control period.

d)Track access charges: As it stands, charges are regulated on a five yearly cycle, which effectively only applies directly to NR. In practice, the price cycle for operators mirrors their respective franchise agreements because the franchise agreements enable changes to regulatory charges to be passed through to fares.150 As such, franchised operators are not susceptible to changes to charges during a franchise period and “are largely indifferent to the charges and incentives regime of NR.”151 The inability of the ORR to apply updated track access charges during the course of a franchise is counterproductive to future efficiency gains in the industry.152

73.The misalignment between the control period and franchising schedules is a fundamental flaw of the current system and undermines further operational alignment between Network Rail and train operating companies; and ultimately efficiency improvements that benefit the passenger. We will examine possible options to rectify this problem, particularly in terms of adjusting franchising and regulatory timescales in further detail in our Rail Governance and Finance inquiry. This will include following up on key recommendations from the Shaw Report.

Incentives for performance and cooperation

74.Train operators and NR are answerable to the Department and ORR through incentives and targets specified in the franchise agreements and the NR licence respectively.

75.Paul Maynard acknowledged that there “is a lot of work to do in aligning the incentives between TOCs and NR.”153 Transport Focus also asserted that franchising, and the rail industry as a whole, has not yet created sufficient joint incentives and targets;154 which, according to the ITS, has “led to a lack of focus on whole industry costs.”155

76.It is widely accepted there is a lack of focus in these targets on the passenger. Chris Grayling, in a speech on 13 October 2016,156 highlighted his intention to reform these incentives to focus on the passenger; possibly by measuring NR’s operational performance in ways that reflect all delays to services (at all stations) and take account of the number of passengers on each service.157

Schedule 4 and 8 payments

77.Because of the different incentives and targets specified in NR and TOCs’ contracts, a number of complex mechanisms have been introduced to bridge the gap and align the two organisations to improve operational performance and drive industry efficiencies.

78.One such mechanism is the Schedule 4 and 8 payments158 in track access agreements which are designed to compensate train operators for planned and unplanned closures on and disruptions to the network. According to Transport for London, “there is relatively little incentive for [operators] to challenge the requirement for closures” because they are fully compensated by NR under these payments.159 However, the operators made a firm point, in their evidence to us, that there were no perverse incentives related to Schedule 8 payments and performance. Jamie Burles commented that “the fines payable for poor performance dwarf [Schedule 8] payments.”160

79.TfL requires bidders for its rail services to assume that 100% of timetabled train mileage is operated and to submit a proposed rate per train mile that TfL can claw back for any mileage not operated due to a planned track closure. In this way, the operator has an additional incentive to challenge proposed track closures.161 Transport for London identified two incidents on the Overground in which the operator—at TfL’s instruction—challenged NR’s proposed closures. On the Gospel Oak to Barking Line, it was able to reduce the closure period from eight to five months on works beginning June 2016; and on the line to Clapham Junction, it was able to reduce the number of weekend closures from 26 to six in December 2012.162

80.There are various other issues identified in the evidence associated with Schedule 8 payments. Balfour Beatty felt that while the rationale behind the payments is clear, they drain money from NR, a public sector organisation that is already has a significant debt at £41.6 billion in 2015–16.163 In 2015/16, net payments of over £100 million were made from NR to operators under Schedule 8.164 Schedule 8 payments also greatly increase the costs associated with, at times, unavoidable infrastructure repairs. It was highlighted that a £5000 cost to NR to repair cables resulting from an accident involving a lorry increased to £1 million because of Schedule 8 payments.165 Schedule 8 payments can also have significant financial implications on NR for ‘acts of nature’ entirely out of their control.166

Route-level Efficiency Benefit Sharing (REBS) mechanism

81.Because the existing regulatory framework largely removes TOCs’ exposure to changes in NR’s costs, they have historically had little incentive to negotiate or facilitate NR cost reductions.167 Joint performance targets have been proposed as a means of rectifying this.168 Specifically, the Route-level Efficiency Benefit Sharing (REBS) mechanism169 was developed by the ORR and introduced during CP5. This was designed to allow annual efficiency gains and losses in NR’s costs to be shared with train operators. Specifically, participating train operators would receive a share of outperformance but would also make a contribution towards underperformance compared to the REBS baseline170 for each route.171

82.Participation in this scheme is voluntary and to date, only GTR, First-Hull Trains and Virgin East Coast have signed up to the programme. This is because other franchised operators are “held captive” to the terms of their current franchise agreement. Additionally the flow of finance from this programme is relatively insignificant compared to the total flow of revenue in the industry. For example, total REBS payments for participants amounted to £203,935 in 2014–15, compared to the £100m plus in Schedule 8 payments.

83.The incentives for cooperation between the operator and Network Rail are not aligned sufficiently with outputs for the passenger. We are encouraged by the Secretary of State’s recent comments on improving the focus the regulatory targets have on the passenger. However, the efforts to further align the incentives in Control Period 5, including the Route Efficiency Benefits Scheme, have been negligible. This is primarily the result of conflict between the control period and franchising schedules. This appears to be a fundamental failing of franchising and the wider regulatory framework and will be addressed at greater length in the Rail Governance and Financing inquiry in 2017.

Joint working and alliancing

84.There was a consensus in the evidence that a joined-up approach to planning and management of the rail network is needed to improve outcomes for passengers.172

85.The Rail Delivery Group was established in May 2011 to bring together rail passenger operators and Network Rail with the clear aim of improving joint working.173 More recently, the Department highlighted its efforts to enable this through the March 2016 Memorandum of Understanding signed with NR. This MoU sets out the new arrangements established to govern the infrastructure enhancement lifecycle. This includes the responsibility of Route Programme Boards, which include “operator representation, for ensuring delivery of the business case, mitigating programme risk and oversight of programme dependencies and interfaces.”174 A number of other arrangements are already in place to enable joint working, including through long-term performance plans and annual joint performance improvement plans between the operator and Network Rail. It was encouraging to hear that Greater Anglia has embedded Network Rail specialists in its teams to improve joint working.175

86.NR has also entered into working alliances with train operators in recent years “to achieve greater benefits for taxpayers and rail users through collaborative working arrangements.”176 Alliances can vary from coordination at a day-to-day management level to deeper commercial arrangements in which the disruption costs and benefits of renewal work come from the same budget.

87.It is generally accepted by industry177 and NR that, in principle, alliancing is a positive way of incentivising greater alignment in infrastructure planning.178 However, progress on alliancing appears relatively limited. In April 2012, NR entered into a “deep alliance”179 with South West Trains putting in place a single joint management team responsible for infrastructure and train operations on NR’s Wessex Route. In June 2015 that arrangement ended in order to meet the respective “internal needs”180 of NR and the operator and to retain the separation of finances. This arrangement was always likely to be limited as the alliance did not supercede the contracts already in place between Government, Stagecoach (the owner group for South West) and NR. The only current substantive alliance is that on the NR Scotland Route, which begun in May 2015. Given recent troubles with Scotrail,181 there are questions as to whether this has actually enabled tangible improvements on that part of the network.

88.One of the main limitations of the alliancing programme is that, where there are multiple operators on a NR route (e.g. on the London North Eastern & East Midlands routes),182 NR is unable to establish deeper commercial relationships with a TOC. This is because it has an obligation to manage relationships with TOCs in a non-discriminatory manner. This was acknowledged by Jo Kaye, Executive Director for Network Strategy and Capacity Planning at NR, who commented that “ … a deep alliance is not necessarily the complete option for all parts of the network”.183

89.The Secretary of State, Chris Grayling, recently announced his intention to expand joint working on the network through integrated operating teams which will be introduced on the South Eastern and East Midlands franchises. He has proposed greater alignment of track and train, through joint ventures, as further franchises are renewed. The East-West Rail Link, which will link Oxford and Cambridge, is a new proposal which will see a private entity take responsibility for track and infrastructure, as well as operating train services.184

90.It is clear that the alliancing programme, while a step toward greater alignment between the operator and Network Rail, has not achieved the desired benefits that were initially envisaged for this programme. We conclude that the programme is ultimately limited by the misalignment between franchises and Network Rail routes that prevents the establishment of deeper commercial arrangements. We do not yet know the details of the Government’s recently announced plans for new alliances in the South East and East Midlands. In light of this we will return to this and other proposals, including the East-West Rail Link, in more depth in our Rail Governance and Financing inquiry; where we will also look at the wider success of governance structures and initiatives, including the Rail Delivery Group, to promote joint-working.

133 Transport for London (RFG0025)

134 Q300; Q302; Performance is monitored by the ORR and for the latest measures of performance, see the Network Rail Monitor.

136 Transport for London (RFG0025); Balfour Beatty (RFG0007)

139 Modern Railway, Peter Hendy interview, April 2016; Balfour Beatty (RFG0007)

141 Network Rail, CP5 Performance Plan, December 2012

142 This will set NR’s outputs for Control Period 6, 2019–24

145 Balfour Beatty (RFG0007)

146 Department for Transport, Report of the Bowe Review, November 2015; HMT, Fixing the foundations: Creating a more prosperous nation, July 2015

147 Balfour Beatty (RFG0007)

148 Network Rail, CP5 Performance Plan, December 2012

149 Network Rail, CP5 Performance Plan, December 2012

150 FirstGroup (RFG0018)

151 Cambridge Economic Policy Associates, Review of factors impacting the form and/or effectiveness of charges and incentives, September 2015, Report for the RDG

152 Office of Rail and Road (RFG0022)

154 Transport Focus (RFG0009)

155 Institute for Transport Studies (RFG0011)

156 The Rt Hon Chris Grayling MP, We put the travelling public first, 14 October 2016

157 Office of Rail and Road, 2018 periodic review of Network Rail (PR18) – Initial Consultation, May 2016; For more information on proposals, see : ORR, Working paper 4: Outputs Framework, July 2016

158 For more information, see Network Rail website.

159 Transport for London (RFG0025)

161 Transport for London (RFG0025)

162 For more detail, see: Transport for London (RFG0025)

163 Network Rail, Annual report and accounts 2016, 2016

164 Network Rail, Regulatory Financial Statements, Year ended 31 March 2016

165 Balfour Beatty (RFG0007)

166 Balfour Beatty (RFG0007)

167 Department for Transport, Reforming our railways, 2012

168 Balfour Beatty (RFG0007); Transport Focus (RFG0009)

170 REBS is based on ORR’s efficient expenditure and income assumptions for England & Wales and Scotland.

171 Rail Delivery Group, Charges and Incentives User Guide, June 2014

172 RMT (RFG0006); Transport Focus (RFG0009); Railfuture (RFG0016); TravelWatch NorthWest (RFG0017); Institute for Transport Studies (RFG0011)

173 Rail Delivery Group (RFG0019)

174 Department for Transport (RFG0003)

177 FirstGroup (RFG0019); Campaign for Better Transport (RFG0013); Institute for Transport Studies (RFG0011)

178 Balfour Beatty (RFG0007)

179 A “deep” alliance can be defined as one in which one of Network Rail’s routes (or potentially part of a route) and a train operator share upside and/or downside risk against an agreed baseline for all or most of their activities.

181 Scotrail, ScotRail Performance Improvement Plan, October 2016

182 Network Rail, Our routes, accessed 11 November 2016

2 February 2017