Rail franchising in the UK Contents

2The East Coast franchise

Early termination of the East Coast franchise

18.The East Coast franchise operates services between London, the north-east, Yorkshire and Scotland. Since 2015, it has been operated by Virgin Trains East Coast, which is a 90% subsidiary of Stagecoach and 10% owned by Virgin Group.40 The franchise was intended to last until March 2023, and as well as running passenger rail services, was supposed to manage the introduction of a fleet of new trains procured by the Department under the Intercity Express Programme.41 In June 2017, Stagecoach announced that it expected to incur losses from operating the franchise and stated that it was in discussions with the Department for Transport about the terms of its continuing operation of the franchise.42 In November 2017, the Transport Secretary announced that the franchise would become a public-private railway and that the franchise would terminate in 2020 to enable this change.43 However, in February 2018, the Secretary of State for Transport announced that the East Coast franchise would end in ‘a very small number of months’ as Virgin Trains East Coast had breached a financial covenant in its contract with the Department.44 The Department told us that it ‘cannot be absolutely sure at this stage’ exactly when the franchise will end. This will nonetheless be the third time this franchise has ended earlier than intended. The franchise previously failed in 2006 and 2009. The Department considers that passenger demand on this franchise is more volatile than others.45

19.The failure of the East Coast franchise is the result of a failure by Stagecoach and Virgin Group to accurately forecast the amount of money Virgin Trains East Coast would earn from operating the franchise because the passenger growth forecasts were wildly wrong. Stagecoach told us that the franchise had been ‘impacted by an unprecedented combination of macro-economic and other factors’.46 The Department and Stagecoach agreed that forecasting passenger demand is more challenging than simply making sure that suitable economic forecasts are used. Stagecoach told us that there have been fundamental changes in the economy and passengers’ perceptions about travel since 2013 and 2014 that called into question the reliability of traditional methods to forecast rail revenue and rail passenger numbers’.47 As we were reminded in a written submission from the National Union of Rail, Maritime and Transport workers (RMT), this created a serious gap between predicted revenue and reality, a story which bears some of the hallmarks of the collapse of the previous East Coast franchise in 2009.48 The RMT also argued that the slowdown in passenger journeys between 2010–2013, precisely at the time when bidders were preparing their bids, did not support the expected increase in passenger numbers.49 The Department told us that it has identified between 50 and 60 factors which impact the growth in passenger demand, including changes in working patterns towards more flexible working and a reduction in the number of people commuting five days a week into London. It told us that the relatively low cost of petrol has also increased competition between rail transport and long-distance coaches and cars.

20.Stagecoach told us that, before taking into account the payments it promised to the Department, Virgin Trains East Coast will make a profit of around £260 million this year. However, since revenue has not grown by as much as expected, the payments due to the Department mean the operator has made a loss of about £200 million to date.50 This is equivalent to approximately 20% of the current value of Stagecoach Group, which told us that this was ‘a very, very significant and painful experience’.51 Stagecoach told us that the franchise would end early because it and the Department anticipated that the franchise would breach a key financial ratio at some point in the next twelve months and that under the contract, the parent company was only obliged to provide £165 million to support the franchise if it made losses.52 We queried why it was not willing to put more money in to keep hold of the franchise, as Stagecoach stated publicly last year that it expected it to be profitable after 2019. Stagecoach told us that ‘the trading position has deteriorated even further since this time last year’, and that it no longer expected the contract to be profitable.53 The Department and Stagecoach both told us that they believed that to date, Virgin Trains East Coast and Stagecoach had met their obligations, including running passenger services and paying the Department premiums, in full.54

21.The Department told us that it is currently evaluating what options are available to it to maintain train services after the current franchise ends. This includes considering operating the services on the East Coast franchise itself, or contracting Stagecoach to keep running services on a not-for-profit basis. We questioned why a private company would be interested in such an arrangement. Stagecoach told us that there had been no detailed discussion about it running services on a not-for-profit basis and that it was right to question why a private company would be interested in this arrangement.55

22.The Department and Stagecoach agreed that in contracting with the private sector to deliver public services, it was important to make sure that the risks sit with the organisation which is best able to manage them. The Department told us that it wants bidders to be ambitious about what they offer passengers.56 However, Stagecoach was clear that bidders would only put forward ambitious proposals if the risk transfer was acceptable.57 It asserted that on the East Coast franchise, all of the risk sat with Virgin Trains East Coast as operator, including risks they were not best placed to manage, such as the risk that the economy does not perform as well as expected at the bidding stage.58

23.In 2011, the previous Committee noted that the high proportion of business and leisure travel on the East Coast franchise meant that it was particularly susceptible to changes in the economy and recommended that the Department should always test franchise bids against a range of different economic conditions.59 The Department told us that it now tests bids against ‘a very pessimistic view of the economy’ but that it only started doing this in 2015, after it let the East Coast franchise. It also told us that it has put in place a new risk sharing model intended to shelter operators from ‘the worst excesses of economic change’.60 It was keen to stress that it did not believe the franchising system as a whole is failing, and that passenger demand is still growing, albeit at lower rates than previously.61

40 Q 1

41 Department for Transport, New East coast Mainline franchise confirmed, 10 December 2014

43 Department for Transport, Strategic vision for rail, 29 November 2017

44 Secretary of State for the Department for Transport, Chris Grayling MP, Rail update, 5 February 2018

45 Q 1, 91

46 Stagecoach (RFU0001), para 2

47 Qq 15, 23

48 RMT Union (RFU0002)

49 RMT Union (RFU0002), Paragraph 12

50 Qq 28, 33, 39–40

51 Q 28

52 Qq 6–7, 80

53 Qq 31–32

54 Q 5, 98

55 Qq 43–44

56 Q 91

57 Qq 19, 38, 43, 91

58 Q 38

59 Public Accounts Committee, The InterCity East Coast Passenger Rail Franchise, 39th Report of Session 2010–12, HC 1035, 9 July 2011

60 Q95

61 Qq 91, 94

Published: 27 April 2018