Rail 458: Franchising needs new model as it nears end of the catwalk

The franchising system has effectively collapsed, contends CHRISTIAN WOLMAR, and now SRA Chairman Richard Bowker will have to respond to the Treasury’s worries about the money-sucking structure of the railway.

Last July I wrote a column entitled ‘What are franchises for?’ (RAIL 441). I was told at the time by Richard Bowker, the chairman of the Strategic Rail Authority, to wait until the franchise strategy statement was published and all would be clear.

Well, nearly a year on, the situation is about as clear as the night sky over Baghdad. The franchise strategy document, published last November, is like those charming models on the catwalks of Paris and Milan: thin and decorous, but fundamentally vacuous. It leaves almost as many questions as before unanswered. Overall, its aim is to give the SRA more control over the franchisees on aspects such as timetabling and performance, and it is supposed to lead to a more sensible apportionment of risk with, for example, the SRA sharing in excess profits as well as cushioning unexpected losses caused by factors outside the operators’ control.

However, the strategy document does little to address the fundamental question about the purpose of franchises and franchising. Franchising, remember, was supposed to:

  • reduce subsidy through competition;
  • stimulate on-rail competition between operators;
  • improve performance through financial incentives;
  • pass on financial risk to the operator;
  • and, through private sector expertise, drive down costs and lead to innovation.

Now I am sometimes being accused of being ‘Mr Grumpy’ in Cynics’ Corner, but exactly which of those aims has happened? And which will be achieved thanks to the new franchising strategy? Subsidy is soaring, competition was always a dead end, and while there is a bit of innovation, any industry is bound to try out a few new things over six years.

The new concept of franchises no longer has on-rail competition as its aim but the SRA still hopes that the bidding process will lead to a reduction in subsidy. However, talk to any operators or bidders, and they will tell you that their starting point for bids will be higher than existing subsidy levels. Sure, there is an element of “they would say that, wouldn’t they?” but there is some firm evidence emerging.

Take, for example, National Express’s bullish statement when releasing its figures in March. Phil White, its chief executive, basically said that it was not interested in maintaining market share but instead wanted to increase profitability, giving a figure of at least 7% to take into account future uncertainty. In truth, his statement could be taken as a desire to pull out of the industry altogether or as a strategy of trying to increase subsidies. Either way, it spells trouble for the SRA.

A return of 7% on turnover is far higher than the industry average of 2.2% in 2000/01, the latest figures available, then only achieved by seven out of 25 franchises. One of these was Thameslink which has been delivering a return of 12%. This enabled it in February to announce dividend increases to its shareholders of 40%, despite the fact that both Thameslink and Thames have recorded sharp increases in passenger complaints and that they are sixth and ninth in terms of performance among the ten London commuter operators. That there is no connection between performance and profitability is demonstrated by South West Trains, the worst-performing London operator, which is making a healthy 10% rate of return.

In truth, the franchising system has effectively collapsed. As Howard Johnston’s excellent and thorough analysis showed (RAIL 457), the system is being propped up by management contracts which operate on a cost-plus basis, rather than allocating risk to the operator. (This was already the case in the Passenger Transport Executive areas where costs have been soaring for a long time. In Greater Manchester, for example, there are real concerns among executive members about the ever-rising cost of running the rail services, which are used by only a tiny proportion of local people compared with the amount going to the well-patronised bus network.)

The managing contract system is the worst of both worlds. It neither transfers the risk to the private sector, nor allows the kind of tight control which British Rail maintained over its costs. There is no incentive on the operator to keep costs down and, whatever the SRA may argue, it is impossible to micro-manage the process sufficiently to know what is happening on the ground.

As an aside, according to an SRA insider, the big mistake was for the organisation not to have taken one of the early collapsed franchises back in-house, in the same way that Network Rail has done with the Reading maintenance contract. He said: “Under Mike Grant [the previous chief executive sacked by Bowker in the autumn of 2001], it was thought that this would be too big an undertaking, and under Bowker, since the collapse of Railtrack, the Government has made sure it did not happen because it would be seen as a further step towards renationalisation.” Taking an operator under direct SRA control would have given a precise indication of costs to use as a benchmark.

However, as Howard Johnston’s analysis suggests, it is going to be really difficult for the SRA to get out of the management contract yoke. Here’s the nub: as management contracts are effectively risk-free, if the SRA is seeking to pass on new financial or performance risk to the operator for five to eight years, then they will require extra subsidy (or reduced premiums) above the rate currently being paid under the management contracts to take account of that potential downside. So, QED: longer-term contracts will require extra bunce, something which the SRA does not have. When I grilled an old railwayman working for the SRA about why the franchising process existed, he said: “The SRA thinks that it ensures operators respond to extra demand better than BR did.” Well, if that’s all they can come up with for paying for this complex paraphernalia, it is not surprising that more and more rail insiders are seeking a rethink.

The franchise process has a lot of downsides compared with a directly managed and operated railway. First, there is the cost. Half the staff in the SRA are employed to oversee or allocate franchises – say, £50 million in staff costs, and half as much again in other expenditure, a guess because the SRA’s accounts are notoriously opaque when you try to separate out its own costs rather than grant to train operators. Then there is the expense of the bidding process, not just financial but as a distraction from the day job of running the railway, especially as we are now into an era of short, five to eight-year franchises which means as soon as the bidding is over, thoughts turn to refranchising.

Thirdly, there is the need to pay high salaries to managers of the train operators. Virgin, for example, has realised that there is insufficient support for chief executive Chris Green at the top and has created two new managing director posts for each of its franchises. Sure, such management would still be needed in a simpler railway, but there would undoubtedly be fewer people with titles like managing director and chief executive which are so expensive. As well as Go-Ahead’s shareholders benefiting from the company’s success, its chief executive, Martin Ballinger, is on £400,000 and his deputy, Chris Moyes, on £350,000, more than the chairman of BR, if it existed today, and most of it from our pockets. Go-Ahead’s chairman, by the way, is none other than Sir Patrick Brown, the permanent secretary at Transport who oversaw the rail privatisation process and trousers £70,000 a year for his part-time role.

So there are two financial black holes in the rail industry, not one: Network Rail which is spending at a rate of £25 billion over the five years between 2001 and 2006, rather than the £15bn allocated by the Regulator, and the refranchising programme. This state of affairs will not be tolerated by the Treasury. When Richard Bowker presents his case for rail for the Spending Review 2004, he will need to answer the Treasury’s concerns about the structure of the railway in which, according to well-placed sources, it is taking a renewed interest.

Railway madness (No. 2)

Continuing the brief series on railway madness (though readers’ contributions are welcome to keep it going): Network Rail has kept a low profile in its initial six months of life, but its honeymoon period will soon come to an end. Indeed, it will be considerably shortened if NR keeps on making decisions like the recent announcement on the bonuses which its senior staff will pick up if various performance criteria are met.

If anything is calculated to convince us that NR is likely to go the way of its predecessor, it is this obsession with creating incentives for its top management. Call me old-fashioned, but I would not write a better article if my Editor, Nigel Harris, told me he would lob me £50 extra if I didn’t make any grammatical mistakes.

Under the Management Incentive Plan, the 30 top executives of NR will be entitled to a bonus of up to 80% depending on a series of criteria including performance, passenger and freight capability, financial efficiency and asset stewardship. Since the chief executive, John Armitt, receives £450,000 and other executive members of the board are all on £300,000, you could ask why they need further incentives to do their jobs properly, just because there is no prospect of any share options or the like available to executives in conventional companies.

This scheme is daft enough, demonstrating a total lack of understanding of the public ethos that must govern the provision of a service like the railway, but is made worse by the fact that safety is included. According to the press release, “the remunerations committee may reduce incentive payments to take account of safety factors or issues”. This is really quite mad and potentially enormously damaging to the railway. The notion that railway people will only ensure the safety of the public if there is extra money in it for them is just unspeakable. You can imagine the conversation after a crash: “Sorry, George, you killed 20 people this year and therefore there is no extra dosh.”

Moreover, it is only the top 30 bigwigs who get the extra moolah, not the guys (and the few girls) who carry out the work, day in and day out, to make the railway safe, without thinking that there will be more in their pay packet if they tighten up the fishplate bolts correctly or make sure that potentially dodgy rails are dealt with.

The most insidious aspect of the MIP is that John Armitt and Chris Leah, both honourable and experienced railwaymen on the board, should have been forced to accept what they must know is a shameful scheme. One cold bit of comfort is that this year, based on current projections, “it is not expected that significant incentive payments would be payable” for the period ending on March 31.

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