Conclusions and recommendations
What went wrong with the franchise
1.Franchises should be able to withstand normal fluctuations in the economic cycle. The fact that this franchise did not suggests that there was very little resilience built into the bid by Stagecoach and Virgin and it bid for the franchise on very optimistic grounds. This was naïve, and it should have been more aware of the financial risks involved, particularly given the history of this franchise and Stagecoach and Virgin’s long history of bidding for and running franchises in this country. We conclude that Stagecoach and Virgin bear prime responsibility for the failure of this franchise. (Paragraph 14)
2.We conclude that, while it is up to bidders to do their due diligence, and clearly Stagecoach and Virgin did not, the DfT encouraged over-bidding by setting unrealistic benchmarks in the Invitation to Tender (ITT) and failing to include the boundaries in the bid process necessary to temper over-optimistic bidding. (Paragraph 16)
3.It is encouraging that the franchising system has now been adjusted to deter further optimism when bidding and is clearly recognition by the Secretary of State of the failings with this franchise bid process. (Paragraph 17)
4.We therefore conclude that the financial stress-testing of the bids by the Department for Transport was not robust enough and was inconsistent with the approach recommended by the NAO following the previous franchise failure in 2009. (Paragraph 19)
5.Had a more comprehensive macroeconomic risk-sharing mechanism been implemented, as per the Brown Review recommendation, there might have been a chance that this franchise would have avoided premature termination. (Paragraph 22)
6.We recommend that the Department clarify, in detail, exactly what its current and future approach to macroeconomic risk-sharing is, in doing so, it should make clear how it has implemented the relevant Brown Review recommendations. (Paragraph 25)
7.Because of the potential implications for the wider franchising market, we conclude that the Department had no alternative but to adhere to its policy of not renegotiating franchises and to let the contract run its course to default. (Paragraph 27)
8.Based on the contract that was originally agreed with the Government, the taxpayer has not bailed out Stagecoach and Virgin. This is because Stagecoach and Virgin had their liability capped at £165 million, which was the amount they committed to the DfT though their parent company guarantee. (Paragraph 28)
9.Sir Richard Branson’s comments in January 2018 left the initial impression that the delay to assumed infrastructure enhancements contributed to the early termination of this franchise. We conclude that Network Rail do not bear any responsibility for the early termination of this franchise. To date, Network Rail have provided all the infrastructure upgrades that it had formally committed to when this franchise was let. A series of other upgrades were assumed to occur by the DfT and VTEC to deliver an enhanced timetable from 2019 onward; though there was no formal funding commitment to these upgrades when the franchise was let. The delivery of these enhancements will now occur but later than was initially anticipated by the DfT and VTEC. This delay would have undermined assumed revenue growth from 2019 onward but did not directly contribute to the early termination of this franchise. (Paragraph 35)
10.We therefore conclude that the Department for Transport are responsible for the confusion around what infrastructure enhancements on the East Coast Mainline were going to be delivered, and when, throughout the life of the East Coast franchise. In specifying the ITT, the DfT should have been aware of the risks involved in delivering the franchise timetable it specified in the ITT, particularly given that the funding had not been committed and there were wider infrastructure enhancement issues happening in parallel elsewhere on the network. Network Rail claims to have provided transparent advice to the bidders around exactly what and was not deliverable and in doing so, fulfilled its obligations during the franchising bidding process. Importantly, though, they were not provided with formal sign-off during the bid process, which might have rectified such confusion before a contract was agreed. We conclude that there was a failure from the Department in not providing Network Rail with formal sign-off of the infrastructure assumptions for the East Coast franchise. (Paragraph 36)
11.We recommend that the Department for Transport clarify exactly what role Network Rail now have in the bidding process and recommend that, if it is still not the case, their relevant representatives have formal sign-off of any bids prior to a successful bid being decided. More generally, we would like to see much closer alignment between the invitation to tender in the franchise agreement and Network Rail’s planned enhancements. The DfT has responsibility to ensure all parties to the franchise bid process are aligned and have equal and accurate sight of what infrastructure upgrades are planned. (Paragraph 36)
12.We recommend that the Department outline how it will specify future infrastructure enhancements in the invitations to tender and what change mechanisms it has in place and whether they can cope with any uncertainty arising from the enhancements pipeline proposals. (Paragraph 37)
Interim operating arrangements
13.While it is too early to know whether the decision to transfer control to the operator of last resort was the right one, we regret there is a lack of a clear plan or timescales upon which the interim operator will run the franchise. We recommend that the Secretary of State outline the exact timescale for the interim operator and clarify exactly how operational and investment risks will be managed until the longer-term Partnership arrangement is in place. We are not aware of the existence of formal obligations and targets for the operator of last resort for the Intercity East Coast franchise. We recommend that whenever the operator of last resort arrangement is invoked, the DfT should revise and publish obligations and targets for the operation of the failed franchise by the operator of last resort in order to provide passengers, taxpayers, Parliament and industry certainty of its business plan, strategy and development plans. This should be done within six months of assuming responsibility for a franchise. (Paragraph 45)
The East Coast Partnership
14.We conclude that greater joint-working and clear lines of accountability through a single person responsible for track and trains offers potential for significant improvement in services. The mechanics and complexity of the current financial and regulatory environment has meant that all previous attempts to establish deep alliances have not worked. It is not yet clear how the East Coast Partnership will more successfully overcome the systemic difficulties presented by the current financial and regulatory environment. Based on the current framework, we conclude that the East Coast Partnership is unlikely to provide scope for the step-change in performance that the Secretary of State might be anticipating. This proposal also risks adding an additional layer of complexity to this part of the network. Passengers will ultimately bear the risk if this proposal goes wrong. This seems to be an unnecessary risk on this part of the network, particularly given that passenger satisfaction is already relatively high at 92%. We recommend that any review of franchising should consider what change would be needed to the financial and regulatory framework to make partnership working a viable and sustainable model for operating the railway in the future. We recommend that the Department set a timetable for publishing the detail of how it expects the East Coast Partnership will work. (Paragraph 54)
15.Before experimenting with this Partnership, we recommend the Secretary of State lay out in detail how the new partnership will work and conduct a proper assessment of its feasibility against those plans. This assessment needs to demonstrate that his proposal will offer better value for money for the taxpayer and better outcomes for passengers than other ways of operating. We recommend the Secretary of State review his decision to go-ahead with this partnership based on the findings of this assessment. (Paragraph 55)
Wider franchising issues
16.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. (Paragraph 61)
17.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 our Committee and Parliament on the de facto reality on the railways. (Paragraph 62)
18.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. (Paragraph 63)
Published: 12 September 2018