5Wider franchising issues
56.The East Coast franchise is the latest in a series of high-profile failings of the DfT-led franchising system, which have resulted in several reviews and inquiries.148 Arguably the most notable failing was with the re-let of the West Coast franchise in 2012, which resulted in the Laidlaw149 and Brown Reviews; the latter of which examined the wider rail franchising programme, looking in detail at whether changes were needed to the way risk was assessed and to the bidding and evaluation processes.
57.Our predecessor Transport Committee published its report on Rail Franchising in February 2017.150 It acknowledged that the rail franchising programme had delivered benefits, and this was a view echoed by many witnesses.151 Concerns were expressed by the Committee with respect to the capabilities of the DfT in running the franchising programme and the sustainability of the current franchising model.152 The latest failure by VTEC on the ICEC franchise brings some of the issues raised by our predecessor Committee to the fore, and lessons need to be learned by the DfT for the wider franchising process.
58.Some of the failings in the bid process of the ICEC franchise do not reflect well on the DfT. It is encouraging to see that they have learned lessons in a number of those areas, and that reforms to the franchising programme have already been implemented. For many years, the franchising timetable has been fluid.153 The main risks to the DfT’s capabilities in the immediate future would be sudden changes to the franchising programme, as has occurred with the East Coast franchise, and what may occur potentially with other franchises elsewhere on the network facing revenue issues.154 While performance bonds cover the direct costs of a refranchise,155 several franchise bids all occurring at a very quick pace can be difficult for the DfT to resource and can potentially undermine the quality of the bid process and the eventual outcomes for the franchise. Unexpected changes to the franchise timetable can also difficult for the owning groups to resource. A bid is a very large and resource-intensive process.156
59.The DfT is yet to reach a steady state with franchising and it is not yet clear whether that is achievable with the current model. The success of the franchising system hinges, in a large part, on accurately forecasting the future economic and market environment. Even with the best of intentions, bidders and the DfT can get their numbers wrong and the implications, as the East Coast franchise shows, can be significant. There are no formal mechanisms for renegotiation. Iryna Terlecky suggested that what was needed was a “franchising system that recognises that life changes”, adding:
Franchises are not set in stone. Working patterns are not set in stone. What passengers want and the impact of competition are not set in stone. It is becoming clearer to me that having a franchise that lasts seven years, when in year seven or year eight you have to deliver what you assumed was needed seven years ago, is potentially not a sustainable model for the future … You can deal with that in a number of ways. You can deal with it by a formal renegotiation point in the middle of the franchise. You can deal with it on a rolling basis as things happen, but that needs a very different mindset in terms of franchising, and will need different skills and competencies at the DfT.157
60.Former Managing Director of Directly Operated Railways Elaine Holt, told us:
It is a question of going back and looking at the risk, and how to cope with change. Changes happen. What is the change mechanism in the franchise agreement? That needs to be looked at.158
61.The DfT, in its written submission, adopted the view that franchise failure is not a major problem, provided it is managed in the right way. There is a balance between the risk of franchise failure and the extraction of value from a franchise for the taxpayer. We do not endorse removing all risk of failure from the system, and believe Brown was right in his review that in a well-functioning, good franchise system you sometimes have failure. But that failure should not be driven by flaws in the franchising process and there is an imperative to preserve a level of continuity on the railways. Iryna Terlecky said that “instability is generally not good for the industry. The railway is a public service and a public/private partnership.”159 A franchising model where franchises default within three years, as occurred with the ICEC franchise, is unsustainable. The East Coast franchise is but one vulnerable rail franchise on the network. There have been reports that several other franchises are either in revenue support, or potentially drawing on their parental guarantees to meet their obligations to the DfT.160 FirstGroup, which run the TransPennine Express franchise, has just made a £106 million provision against its revenue shortfalls and are drawing on their parent company guarantee.161 We heard conflicting views from the DfT about the risk of these franchises defaulting in the same way as VTEC did with the East Coast franchise. Simon Smith initially said that “we do not have any franchise at short or medium-term risk of financial default”.162 Polly Payne later clarified:
With both Govia Thameslink Railway (GTR) and Northern, we are at the moment looking at whether they have performed to their contract, and, as you know, with GTR in particular, we have a hard review happening at the moment. We do not know what that hard review will show yet, but if it shows that they have triggered an event of default, or they have been out with their contracts such that they can be terminated, that is a possibility, and in that case we would mobilise the operator of last resort.163
62.The Secretary of State also acknowledged that he had “stepped up the capabilities of the OLR team in case we had to take back control of [the GTR] franchise. That would not be for financial reasons; it would be for operational reasons. “164 But according to the Secretary of State, no other franchises, apart from GTR, “fit into the service provision set-up that might lead to the operator of last resort.”165 It is unclear, at this stage, how the contracts of these other franchises that are in revenue support are different from that used in the East Coast franchise and what mechanisms are available for renegotiation, outside of franchise default. We recommend the Department outline what mechanisms it has available for franchise change and renegotiation. We also recommend that it keep the Committee informed about any franchises that look likely to default on their contracts and whether it is resourcing the operator of last resort to take over any of these franchises, and find a way to brief Parliament on the de facto reality on the railways.
63.Given the problems on these franchises and the possibility of franchise failure, we conclude that the Government has not found the right balance between the risk of franchise failure and return they might obtain from encouraging ambitious bids. We recommend that the Department revisit its approach to franchise failure, which should be embedded in how they assess the risk and feasibility of each bid.
148 The Laidlaw Inquiry (published December 2012) examined what happened during the West Coast procurement and why, with the aim of establishing the lessons to be learned.
149 Department for Transport, The Brown Review of the Rail Franchising Programme, January 2013
150 Transport Select Committee, Rail franchising, Ninth Report of Session 2016–17, 5 February 2017
152 Transport Select Committee, Rail franchising, Ninth Report of Session 2016–17, 5 February 2017
Published: 12 September 2018