Rail franchising Contents

Conclusions and recommendations

Is franchising delivering for the passenger?

1.It is clear that franchising coincided with significant growth in passenger rail but has not yielded all the benefits for passengers envisaged when the Government made the case for privatisation in 1992. Many metrics of performance are plateauing against the backdrop of substantial growth in premiums paid to Government. Ultimately, it is the passenger who pays: rail fares have grown significantly in recent years. This is the result of a deliberate decision by successive governments to shift the burden of paying for the railways from taxpayers to passengers. We hope that the recommendations set out in this report will deliver better value for money for passengers. (Paragraph 15)

Passenger rail competition

2.Franchising delivers the most benefits to passengers where there is robust competition between bidders to operate services. The direct award dependency of the Department and recent fall in market interest demonstrates that genuine competition has been restricted to a limited number of franchises. This core policy objective is not being met and the potential benefits from this model are therefore not being maximised by the Department. We recommend that the Department take steps to streamline bidding costs where possible; even if the effect of this on market interest is likely to be marginal. The Parent Company Guarantee is crucial in protecting the public purse and should not be removed or amended significantly. Wider reform is required, possibly through open access operators in appropriate areas, or creating smaller franchises, to attract new entrants into the market and promote competition in rail. Without change it is difficult to see how the current model will be sustainable in the longer term. (Paragraph 26)

3.Open access has been a success, albeit on a limited scale to date. The balance of evidence points to potential benefits in open access having an expanded role on long distance routes, beyond just filling marginal capacity or connecting unserved markets. Although it is not a complete substitution to franchising because of fragmentation risks. It is important to note that there are operational complexities that need to be addressed and we acknowledge that it will take time to test open access on a larger scale, to fully understand its feasibility, particularly in terms of operational risks. (Paragraph 34)

4.In the context of declining market interest in franchising, open access may be an avenue for new and smaller entrants into the market. Additionally, given the lack of an operator of last resort, open access operators may be able to serve a role in franchise enforcement—possibly through the reallocation of capacity away from underperforming franchisees. (Paragraph 35)

5.Reforms are needed if open access is to be expanded on the network. We recommend that the Department and the ORR work together, as they develop the financial framework for the railways over Control Period 6 (2019–24), to present a comprehensive set of reforms to track access charges. These reforms need to manage the differing requirements of OAOs and franchisees and ensure that operators, taxpayers and passengers get a fair deal. A specific proposal for a PSO levy should be put out to consultation over the next 12 months, so that a new regime can be introduced from April 2019. We further recommend that timetabling spaces for open access services are determined upfront during franchise development prior to the publication of the Invitation to Tender. This will provide the certainty that industry needs to plan, particularly at the bidding stage of franchising but it will also help to encourage OAOs. (Paragraph 42)

Taxpayer support and the transfer of risk to the private sector

6.The transfer of financial risk to the private sector was a central premise of rail franchising, but historically there has been a relatively low level of financial risk from operating a passenger rail franchise. However, falling profit margins for passenger operators in recent years, and the increasing size and complexity of franchises, appears to be increasing risk to private operators. Much of the financial risk in rail has always resulted from maintaining and enhancing the infrastructure and this is still the case, with whole-of-industry Government support still substantial. There are wider 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. (Paragraph 52)

7.With respect to the ongoing problems on the TSGN franchise, the ultimate financial risk remains with the taxpayer. We recommend that in response to this report, the Department publish updates on the financial losses to the taxpayer from the TSGN franchise and set out the options available to recoup these losses. Given the exposure of the taxpayer to the failings of this franchise, it is unacceptable for the Department to maintain its current ‘arms-length’ approach. We recommend the Department intervene to ensure that all possible steps are being taken to stop the haemorrhaging of income. In response to this report, as well as setting out the steps the Department is taking, a full explanation should be given of the range of options considered in dealing with this franchise and why the current ‘arms-length’ approach was deemed suitable. If GTR is officially found to be in breach of its contract, we recommend the Department 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. (Paragraph 54)

Structure of franchising

8.There are potential benefits from operating smaller franchises, particularly in terms of providing a greater market focus for the operator. There is also less financial risk from taking on smaller franchises, which may enable new entrants into the franchising market. A wide restructuring of the current franchise system would, however, be prohibitively impractical because of the resource burden this would create for the Department and the restrictions from current franchise contracts. We therefore recommend that, as franchises expire, the Department considers whether they can and should be restructured to align better with the specific market they serve. (Paragraph 62)

9.We believe that there are benefits from procuring longer franchises, particularly in terms of incentivising investment and efficiencies from an operator. However, a one-size-fits-all approach is inappropriate. We recommend that the Department, upon the expiry of existing franchises, seeks to procure longer franchises where a franchise’s operational risks are relatively low and historical performance has been strong. This would have the dual benefit of enabling operators to improve efficiencies and provide more space for the Department in a highly congested franchising schedule. It is important that the necessary enforcement levers against underperformance, as well change mechanisms for infrastructure works, are contracted for by the Department for franchises with longer terms. The Department should also find more innovative ways of contracting with operators to mitigate the unpredictability of financial risks over longer term horizons. (Paragraph 68)

Franchising and Network Rail

10.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. (Paragraph 73)

11.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. (Paragraph 83)

12.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. (Paragraph 90)

Departmental capabilities

13.The Department needs to find more innovative and streamlined ways of engaging with passengers and wider stakeholders when consulting on rail franchises. It is clear that consultation documents in the order of 60 to 70 pages and formal written responses are not the most effective in engaging with the wider public. We recommend that the Department publish a rail franchising public engagement strategy. This does not have to be exhaustive. A short document and associated webpage would provide the public with a clearer view on how to engage with franchising. We also recommend that the Department engage with relevant rail user groups on a more substantive basis at the beginning of the consultation process. (Paragraph 96)

14.We believe that the Department’s commitment to transparency is undermined by the lack of information following a franchise award. Commercial sensitivities limit the amount and type of information that can be published. Acknowledging this however, we recommend that the Department publish a scoring system, possibly in the form of a weighted index, following a franchise competition. This would omit commercially sensitive details but give the public and industry a better understanding of the basis, in terms of quality and price, on which a franchise has been awarded. (Paragraph 100)

15.The experience from the East Anglia franchise competition shows that there is an obvious disconnect between franchising and the Government’s wider transport policy objectives. As concluded in our previous report, integrated transport planning is crucial to improving surface access to airports. It is simply unacceptable that a service that provides significant economic and social benefits, within the context of constrained airport capacity in the South East, be entirely ignored in the bidding process. We recommend that the Department, Network Rail, Greater Anglia and Manchester Airport Group work together to develop plans for journey times improvements on the Stansted Express. Improvements would heavily and directly benefit MAG and as such it should consider making a funding contribution to the associated cost. The wider role of third-party investment in rail will be examined in our Rail Governance and Finance inquiry. (Paragraph 105)

16.We do not recommend moving to a single measure upon which to measure operator performance but we do recommend the Department streamline franchise specifications, taking an outcome-based approach. This would provide operators with more flexibility in delivering tailored services to passengers based on individual market requirements, which change over time. It would also reduce the burden on prospective operators in the bidding process and on the Department in developing the ITT and in the monitoring and enforcement of a franchise. However, it is also important, where an individual franchise warrants it (e.g. on largely urban, commuter-heavy franchises), that detailed commitments can be set out, related particularly to service quality provisions, in franchise agreements with the expectation that the TOC will be held to them. (Paragraph 111)

17.Despite the Department’s consistent claims of a commitment to transparency, our experience would suggest that transparency in franchising monitoring appears to be very poor. It has taken significant effort from this Committee to obtain basic information around GTR’s performance benchmarks and timetabling which are not available publicly. Further, in allowing GTR to change their performance benchmarks and timetable, which effectively enabled them to avoid breach of contract, the Department has not actively intervened in a manner proportionate to the problems on the TSGN franchise. GTR have effectively been given a penalty holiday because of this industrial dispute. (Paragraph 115)

18.The way the force majeure provisions are currently drafted in franchise agreements provides operators with far too much leeway when dealing with industrial disputes. We accept that part of the industrial action is outside the control of the operator. Yet the ability to respond to it, particularly in terms of managing longer term staffing levels, is very much within the control of the operator. We recommend that in future contracts, terms are drafted in a way that has a clearer definition of what qualifies as force majeure and is commensurate to the degree of control of an operator has in dealing with an industrial dispute. (Paragraph 116)

19.We welcome the Minister’s commitment to make franchise performance reporting more transparent following our extensive investigations and ongoing pressure. It is a significant step forward and goes some way to increasing the accountability of operators to the public for poor performance. We recommend that the Department outline, in detail and with a timeline, its plans to incorporate these reporting provisions into existing contracts. We also recommend that when the Government publishes the promised performance benchmarks, it does so in an easy to access format which is not hidden away separately on individual operator websites. The data must be centrally located on a dedicated and visible webpage that shows the performance of all operators and makes clear whether operators are failing to or are at risk of failing to deliver the services the Department has contracted them to provide. It must also be possible to track any agreed changes to the levels and quality of services and a clear rational for each such agreed change should be easy to find. This has implications for the transparency of the entire franchising process. (Paragraph 120)

20.We were concerned to see that GTR earned a net payment in the first year of operation on the TSGN franchise, with performance rewards greater than penalties. We are also disappointed that performance penalties on that franchise have been capped which disincentivises performance once it has deteriorated beyond the breach level. We conclude that by capping performance penalties the Department has not drawn up a contract in the public interest. We recommend that the Department learn lessons from this episode and that it overhaul its contracting approach to performance penalties to ensure that penalties are more proportionate to the revenue obtained from a franchise. As a starting point, it must no longer contract for a breach level cap on penalties in the way it did so on the TSGN franchise. There may be wider issues affecting other franchises but it is difficult for us to make any other specific recommendations as we have only seen performance penalties for the TSGN franchise. (Paragraph 123)

21.We are of the view that the Department does not have sufficient capacity to revoke a franchise from an operator, particularly of the size and complexity of TSGN. With a rather weak penalty regime, the Department appears to have very few levers with which to manage performance and enforce a contract. An out-of-date enforcement policy shows a complacency on part of the Department in terms of prioritising franchise enforcement. (Paragraph 126)

22.As an immediate priority, we recommend the Department update its enforcement policy by May 2017. In doing so and given the potentially high costs of running an operator of last resort, we recommend the Department consider new ways of enforcing the contractual terms of a franchise. For example, the Department should consider contracting for the reallocation of capacity to an alternative operator in the event of sustained poor performance or default. This could potentially mitigate the cost of running an operator of last resort and also provide a very genuine enforcement threat against poor performance. (Paragraph 127)

23.We question whether it is effective for one of the commercial partners to a franchise (i.e. the Department) to also be the enforcement authority. In light of this, we recommend that the Government transfer enforcement and monitoring capabilities of franchising to the Office of Rail and Road or another independent body. It should bring forward a consultation setting out the options for independent enforcement—including the ORR option or the creation of a new body. This consultation should also consider the costs of doing this and examine the implementation issues for the ORR in terms of the impact on its other functions and resources. (Paragraph 131)

24.The Department has only procured six competitive franchises since 2012. We do not believe the Department has sufficient capacity to procure the seven franchises that are scheduled between 2017 and 2019. One of those will be the complex Intercity West Coast Partnership. Recent experience with TSGN does not fill us with confidence that the Department can deliver this sort of complex franchise. Further, the West Coast Partnership will inevitably be a significant resource burden on the Department and has the potential to jeopardise other franchise competitions in that period. Unless, within the timescale required, major changes advocated in this report are implemented and the Department is resourced to manage the procurements, we recommend the Department should consider direct awards for its highest performing franchises due for renewal between 2017 and 2019. While not desirable, particularly in terms of limiting competition and creating further change in the franchising timetable, this proposal may mitigate the costs from mismanaged franchise procurement likely to result from a congested franchising schedule. (Paragraph 135)

25.We welcome the commitment by all parties to a coordinated changeover of the South Western franchise in 2017. Yet the success of a franchise changeover depends on the assumptions and information provided by the Department. Given the gross inaccuracy of assumptions and planning for the TSGN franchise and the void in capability this represented, we believe that there is a performance risk to a new operator, and therefore passengers, from the South Western franchise changeover being scheduled in the middle of major infrastructure works at Waterloo. The practicalities and costs of delaying this franchise are likely to be significant and may outweigh the benefits of improved coordination in planning with the incumbent. The current schedule for the South Western franchise competition should remain as planned. More broadly, we recommend that consistent operational management be maintained during any future major infrastructure works scheduled for major London terminals. (Paragraph 138)

26.While we acknowledge the potential benefits of having a single operator coordinating services on the West Coast Main Line and the new HS2 line, there are competition and planning risks associated with operating a franchise of this magnitude and complexity. And while this decision was informed by consultation from the now delayed West Coast franchise re-let, we are concerned that this specific decision has been made without any formal consultation; and that it was announced without any accompanying business case or evaluation for the public and stakeholders to consider. We recommend that the Department publish the business case for this decision, clearly outlining the balance of benefits and risks from this decision. We are pleased that the Government published further detail in the recent prospectus on how it intends to structure and operate this franchise in the future. (Paragraph 145)

27.Despite the recent efforts of the Department to improve its franchising operations, there is extensive evidence pointing to serious deficiencies in its franchising capability and capacity. We are of the view that the Department’s progress since 2012 is insufficient to warrant proceeding with the current structures and personnel in place. While we still believe the Department has an important role to play in franchising, we do believe certain functions of the franchising process may be better placed elsewhere. (Paragraph 148)

28.Because of this, we recommend that an independent and publicly available review of the Department’s franchising functions be commissioned. In addition to reviewing the Department’s capabilities and capacity, this can include consultation regarding the transfer of the monitoring and enforcement functions to the ORR. This should also outline the Department’s strategic direction for franchising, including but not limited to the way it wishes to structure and plan for future franchises, and how it plans to manage the issue of open access. (Paragraph 149)

2 February 2017