Rail 441: So, Chairman Bowker – just what are the franchises for?

The creation of Network Rail has effectively renationalised the infrastructure, but CHRISTIAN WOLMAR believes the other main pillar of the privatised railway – the franchises – have also failed to deliver, and they too are being run by the state in the shape of the SRA.

At the first conference that Alistair Darling addressed as Transport Secretary, I managed to ask him a question at the end of a long Q&A session. As he had rounded on the unions’ demands for the renationalisation of the railway, I asked: “Why didn’t he make them happy by simply telling them that, in fact, the Government had renationalised the railways.” Not surprisingly, he didn’t take the bait, merely reiterating that he had no reason to pander to the unions.

That was in early July at the Railway Forum conference and the question was principally referring to Network Rail which, as everyone outside the Treasury knows, is pretty much back in the public sector. But given what is happening in the franchise process, it is apparent that they, too, are being run by the state, in the guise of the Strategic Rail Authority. As I have mentioned before, all the regional railways franchises have over the past three years effectively gone bust and had to be rescued by the SRA. They are now being operated on a cost-plus basis which means that the SRA pays the cost of running the franchise and a bit extra for the train operator’s profit.

But now, amazingly, the same thing is about to happen to the Virgin franchises. Ever since the Virgin West Coast deal was signed in 1996, I have always argued that it would not be fulfilled. The reason was simple. It was a 15-year franchise by the end of which Virgin was going to be paying £220m in annual premium to the Government. It was always a pipedream, something that looked good in a press release back in the midst of the privatisation controversy, but it was never going to happen.

Now as a side-effect of Railtrack not being able to fulfil its commitment to provide a 125mph railway, let alone a 140mph one, the terms of both the Virgin franchises, West Coast and CrossCountry, have been reset.

The full extent of what has happened could not, however, be gleaned from the Strategic Rail Authority, which merely issued a four-paragraph press release welcoming the signing of ‘an interim agreement’ with Virgin on the two franchises. As an aside, this is a disgraceful bit of obfuscation on the part of the SRA since it was party to the agreement that it was ‘welcoming’. The SRA has become an all-powerful body in the rail industry, disbursing billions of pounds of cash and making decisions that affect everyone involved in it, from passengers to train operators. It is therefore incumbent on the authority, as a matter of course, to be as open as possible about its dealings and in particular its use of public money. Lecture over.

Instead, it was left to Stagecoach to issue details of the deal as it is a publicly-quoted company which owns nearly half of Virgin Rail and therefore must report significant events to the Stock Exchange. Under the terms of the deal, Virgin will receive an extra £106m to run the franchise for the current year but most interesting is what happens next. The statement revealed that if no permanent agreement has been reached by the end of this financial year, then the franchises would be run as management contracts. For West Coast, Virgin will receive a fee of 2% of revenue and, for CrossCountry, 1% of revenue. The difference seems to be because CrossCountry may be offered to other bidders and therefore it is a disincentive for the management contract deal to continue in the long term.

As another aside, the SRA is incandescent that Stagecoach suggested to analysts the deal might be worth between £250m and £465m. This, apparently, was a back-of-the-envelope calculation based on what might happen if the delay to improvements on the West Coast line continued for a long time. The SRA responded that it was the result of a conversation that had never taken place and that “it was as near to a lie as you can get.” These strong words, incidentally, were reserved for Stagecoach rather than its partner, Virgin, and do not augur well for the company’s future relationship with the SRA.

The SRA insists the management contracts will not mean that all the financial risk passes back to it and hence the taxpayer: “We will be going all over their books like a rash,” a spokesman said with a slightly unfortunate metaphor. So, if the costs overrun or the revenue increases, it will still be Virgin that loses out or benefits and there will be targets to which Virgin will be held.

However, a Rubicon has been crossed. Once the SRA begins micro-managing a franchise in this way and starts to make judgements about how future costs and revenues may behave in order to assess the amount of money that ought to be paid to Virgin for running the franchise, then much of the risk has been transferred to the public sector. The public sector is beginning to second-guess what the private companies can do.

Although this is presented as an interim deal, it puts Virgin in an incredibly strong position, especially for the West Coast as there is no other potential bidder, in the future negotiation. Basically Virgin knows that the SRA has no choice than, ultimately, to sign some sort of deal. It would be disastrous for the SRA if Virgin were to walk away, so it really has no sort of negotiating position at all. The Emperor, Richard Bowker, may be short of the rest of his attire, as well as a tie.

The deal represents another unravelling of the structure of the industry created by the Tories and raises the broader question of what franchises are for. I have asked this question before in this column and received no satisfactory answer. Originally, the purpose of franchising was to drive down costs in the industry, transfer risk away from government and bring in private sector expertise. The first of these was, of course, the driving force. All the original franchises had descending curves for the amount of money that would be paid as subsidy. In the case of some of the early ones, notably South West Trains and Great Western, the descent slope was very gentle, while for others, particularly Virgin West Coast, it was as vertiginous as the North Face of the Eiger.

The idea was that subsidy could be phased out, or at least dramatically reduced over the life of the franchises. As we now know, that was a ridiculous fantasy whose pursuit has, oddly, cost far more public money than it has saved. As for risk, half the franchises have either had to be baled out, given extra money or had their ownership transferred. In terms of risk transfer, franchising has been an almighty flop. This will always be the case. Once a private company knows that government is going to rescue the service should it get into financial difficulties, then transferring risk becomes impossible.

As for private sector expertise, there is little to say that has not been repeated time and again. Suffice to add that the railway industry is hardly the textbook which writers of the future will look to as a fount of best practice.

So to sum up: franchises have not delivered the investment, the expertise or the subsidy for which they were designed. In the privatised railway Mk 2, which we now have, their role is unclear. It is noticeable that in the SRA’s annual report published on 18 July, franchising barely gets a mention. In his introduction, Richard Bowker devotes one paragraph to franchising and in the rest of the text there is barely a whole page out of 50.

The SRA did announce last December its strategy on franchise extension and replacement. But it is merely a piece of ‘ad-hocery’ with no clear purpose. It is summed up in the annual report: franchise operation was separated from infrastructure investment; 15-year franchises could be granted, but only if performance and quality targets were delivered and there would be break points (which means they aren’t really 15 years); and there would be “an incremental approach to additional services and developments recognising the limited availability of additional funding for many franchises”.

Oh, yes, and the refranchising process, which had been on ice, was restarted but has shown precious few results yet. As a third, and last aside, that is because no one knows what franchises are for. The first Franchising Director, Roger Salmon, and his successor, John O’Brien, managed to franchise out the whole railway in just over a year because their objectives were clear, albeit limited and short-sighted.

So, the question for Bowker and his chief franchise henchman, Nick Newton, is: “What is a franchise for?” Since that is not contained in the SRA annual report, perhaps one of them would like to drop RAIL a line to tell us.

By the way, in the next issue I will be summing up the railway class’s performance – including those pupils who have been expelled or are no longer with us – for the past year, as I did last summer; so if you have any class reports on how pupils have fared over the past year, please e-mail me. Confidentiality guaranteed, of course.

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