Rail 646: Franchising and Network Rail in the spotlight

My oft-repeated question of ‘what is franchising for?’ will need to be answered by the new government as it faces a tricky situation in relation to train operators. On the one hand, both parties in the coalition support the notion of longer franchises, with more investment coming from operators, but, on the other, the financial constraints caused by the budget deficit mean that there will be pressure from the Treasury to maximise premium payments.

 Therefore the question will resonate. Is franchising designed to transfer risk to the private sector? Hardly, given the recent record of failures. The aim of attracting large scale investment from the private sector is also a myth. Yes, Chiltern does it, but on the basis of a generous long term franchise settlement, which will not be available in today’s climate. So the purpose of franchising can only be to bring out the best in the private contractors who, according to current thinking, will make a better fist of it than government.

 But we all know it does not work that well. The franchises are a mixed bunch, ranging from those that have managed to create a customer focussed ethos to those whose staff skilfully exhibit a blend of all the worst features of both private and public sectors. The staff are often disaffected, poorly treated by remote managements belonging to the huge companies that now own all the franchises.

 So here’s a potential solution which the new ministerial should examine before letting any new franchises. It comes from Steve James, an East Coast driver who used to be a finance director but who went back to working for the railways a few years ago where he had been an apprentice, because ‘it was where I always wanted to work’.

 As a finance expert, he has identified one of the most obvious problems with the franchising system. If companies are going to be asked to bid for longer periods, their estimates of revenue in the later years of the franchise are likely to be pretty arbitrary. The Department for Transport will be under pressure to allocate franchises to the company making the most daring bid, even if it is totally unrealistic.

 Instead, Mr James argues that rather than having the usual suspects conduct a bidding war, he suggests that future franchises should be co-operative efforts with the involvement of both staff and managers and the risks shared. The franchise would be run by a ‘strategic’ board consisting of all the stakeholders – passengers, unions, Network Rail – and the staff would be incentivised by having a 10 per cent share of the company. A set level of profit would be predetermined for reinvestment in the franchise, and anything above that would be distributed to the various shareholders, with 10 per cent going to the staff.

 The board would be constituted in such a way that no one party would have a controlling interest. The Department would have 40 per cent of the votes, but would need to convince other stakeholders to obtain a decisive vote at the board. Day to day management would be through a conventional operating board.

 This arrangement could be applied to any franchise. The notion of making profits predicated mostly on successfully guessing the way that the economy is going has always been ludicrous. And in the current climate the problem has been exacerbated. The failure of two successive East Coast franchises highlights that the present model is ill-adapted to difficult economic times. Moreover, at present several franchises are in ‘special measures’, i.e. trapped in the cap and collar system which was devised to limit their profits in the event of a boom but in fact now means that in several cases the Department is shoring them up. Under the arrangement, all but a fifth of any shortfall in revenue below 94 per cent of expected income is paid by the government. A fundamental problem of this arrangement is that if a company falls badly behind projected revenue, with no hope of making up the shortfall, there is a disincentive to invest in improving facilities since most of any extra income will go to government. These arrangement will have to be renegotiated anyway since Philip Hammond is not bound by his predecessor’s ‘no negotiation’ position.

 So can the coalition create this coalition of interests. Of course there are obstacles. Mr James put this idea to the outgoing Transport Secretary, Lord Adonis, just before the election and while it was received favourably, it was pointed out that the bureaucracy required to create this structure would be complex. Moreover, there will be widespread opposition, most predictably from the Association of Train Operating Companies whose members like the idea of gaining substantial returns from little investment. The unions, too, might be reluctant. They are traditionally reluctant to become involved in the management of organisations, preferring the ‘them and us’ stand-offs from which they have profited and the travelling public have lost out. However, the Libdems have shown an interest in co-operative ways of working and Mr James could be pushing at an open door there. This could be an early test of whether there is any Libdem influence on transport policy or not.

Network Rail in the spotlight

If the letting of franchises will pose immediate questions for the new government, the financing and governance of Network Rail are bound to exercise ministers in the longer term given the need for budget cuts and the lack of any control over the organisation. The weakness of the Officer of Rail Regulation’s oversight is becoming ever more apparent by the day with a reluctance of the regulator to push Network Rail, even when it does make criticisms. This was well demonstrated when the ORR issued its annual assessment of Network Rail’s performance, and yet its executives seemed reluctant to push home the logic of their own criticisms (see Nigel Harris’s blog on this).

 I will be taking a close look at the options for the future of Network Rail (suggestions welcome) over the next few months, as I suspect that the company will be subjected to major changes during the course of this government. The taunting tone of Iain Coucher in response to criticisms of his ridiculously inflated salary and bonus – ‘I am worth every penny’ screamed the headline in The Times though Coucher did not actually say those words – guarantees that there will be greater scrutiny of the company than under the previous administration. Coucher’s insistence that Network Rail is a private company, which everyone in the industry knows is a myth – why else does the government include cuts to Network Rail in its savings –   does not help his organisation’s cause.

 The area of most concern is the growing debt. Network Rail treats the question of its ever mounting debt with similar disdain to Coucher’s attitude on his salary. Its statement accompanying the provisional figures for the past year merrily state that ‘net debt rose to £23,838m from £22,307m, to help fund our investment programme, but had a lower gearing (debt to regulated asset base) ratio of 64 per cent – down from 70 per cent’. But the Regulated Asset Base – essentially what the company is notionally worth – is a wholly artificial figure used to determine how much Network Rail can raise in access charges. It bears no relation to what the company is actually worth and therefore its relationship with the debt is irrelevant.

 The two key figures are the level of debt and the amount paid in interest which is around £1.2m, due to rise to £1.7m over the next four years. Network Rail has a turnover of under £6bn, and to have debts of this order, with no suggestion of trying to reduce them is not sustainable. It is living off our children’s taxes.

 The railways in Greece are under enormous pressure for precisely the same reasons, a mounting unsustainable debt. Admittedly, like the Greek economy, the situation if far more serious. The Greek railways are in hock to the tune of 9.5 bn Euros and yet have revenues of just under 200m Euros annually, a figure that is dwarfed by interest repayments of 428m Euros. Closures, privatisation (done that!), redundancies and fares rises are all in the offing. While Greece is clearly much further down the road to insolvency than Britain, the situation of its railways has far greater resonance. Building up debts that can never be repaid, and have to increase annually as a disguised subsidy, is no way to run a railroad. When Japan’s railways were privatised in 1987, the government had to take on a debt of 25 trillion yen – that’s around £200 billion pounds. At some point, the government has to stop funding the railways by allowing Network Rail’s debt to increase massively each year. And then the similarities with Greece might be all too painful.

  • The ATW bid that won the X-C franchise from VT exhibited all the faults described in your early paragraphs…. Where are they now?

  • Keith

    As you say, it’s hard to see how the projected revenue system can work with long term franchises.

    Here’s an idea for an alternative. For the profitable franchises such as East Coast, the DfT gets an agreed share of the profits. Once the franchise specification has been drawn up by the DfT (service levels, fare regulation, investment required etc), the winning bidder is then chosen in a “beauty contest”. The bidders are judged on their track record, from both a passenger point of view and a financial point of view (ie their ability to generate profits). Perhaps Passenger Focus could judge from a passenger point of view, and the NAO from a financial point of view. The final decision is taken by some kind of independent arbiter.

    This system could also be applied to the currently non profitable franchises. They could be made profitable by some type of subsidy formula, eg payment per passenger, the DfT paying a proportion of ROSCO costs, reduction in track access charges, etc.

  • Dan

    “…it was pointed out that the bureaucracy required to create this structure would be complex…”

    No experience of that on the railways then? Perhaps John Major (or his Treasury advisors) could be brought in to help if it is not quite complex enough….

  • Rhydgaled

    Where ever did the idea of having ROSCOs come from? As far as I can see, the idea was plain DAFT, there is no good reason for having another organisation (out to make profit) in the system. Whether there are advantages to privatization in general I can’t tell (still I think it would have been better to keep the railways nationalised) but there is no advantage to having ROSCOs.

    For the moment, I’ll assume, against my personal opinion, that there are advantages to privatization and try to make a suggestion without ROSCOs. Now, had the goverment retained ownership of the nation’s rolling stock assets, and gave the TOCs control of them as part of their franchise aggreements, the TOCs would only have to pay for maintenance and Network Rail track access and siding occupation fees. This would mean the TOCs would have lower costs, meaning lower goverment subsidy is required. How much is a class 153 unit worth anyway? one of these would apparently cost £100,000 a year to lease but I cannot see one being worth much more than £800,000. Therefore, assuming the terms of the lease in question do not include maintainence, in the life of a 10-year franchise it would be cheaper for the TOC to buy the stock themselves.

    There are of course other great problems in the privitized system, Network Rail’s costs being greater than equivelent works in mainland Europe being one of them, but having ROSCOs has to be one of the biggest mistakes in the railway’s history.

  • RapidAssistant

    You’ve hit the nail on the head Rhydgaled – you touched on it, but all the old British Rail rolling stock (which still makes up probably more than 50%) of the the current fleet would have been depreciated to a value far less than the ROSCOs value it at.

    We have ludicrous situations such as that on the Isle of Wight line (probably the best example) where SWT are using 70 year old converted London Underground trains, but still paying the ROSCOs a fortune to lease them. There are plenty of more examples like this on lines which are still using 30 or 40+ year old multiple unit stock which would have been depreciated down to zero by BR years ago, but again – the ROSCOs are making a mint from their lease.

    I think the ROSCOs are one of the most under publicised scandals to come out of rail privatisation.

  • Andy

    If we are to attract private finance then risks do need to be capped or it will be built into the price by any bidder. If there was less fluxuation in franchise duration that would most certainly help and a move to 15 years would help bidders build a longer term view at improving the asssets as well as invest improvements to its wider service..

    Little is mentioned of the pescriptive timetables imposed on bidders for new franchises – how about giving more freedom for the TOCs to suggest creativity? This might of course mean that the little remote stations getting a signficantly reduced service.

  • Dan

    Of course this is the problem Andy – the moment you want subsidy (which reduces risk) then you involve the taxpayer – and more importantly the tax payer’s representatives aka MPs – then you have a powerful case for ensuring that little remote stations do not get axed – after all you are expecting the taxpayers who live near them to pay the subsidy that minimises the risk…

    If none of this was the case then the private sector would build some new lines would it not…without subsidy of course.

    Sadly I’m also not convinced about the point about improving the assets – I agree it should happen, but the bus companies have pretty clapped out bus fleets and they have no limit on their timetables – and they divested themselves of bus stations etc that passengers migth have found quite useful – consigning their customers to standing by a pole in the road (unless the council coughs up for decent bus shelters).

    If it was down to Ryan Air and co – would they provide decent airport terminals? I doubt it – I’d expect they’d be happy with a load of portakabins if they coukd get away with it!

  • RapidAssistant

    On the points about subsidy and allowing the private sector free rein – lets turn the clock back 130 years and look at how competition and rivalry and the desire to make money shaped the whole rail system to begin with. It was profitable – yes – but then the only competition was from the canal boat and the horse. The network is stuffed full of idiosyncracies and compromises which haunt us to the present day due to a lack of planning.

    That’s why regulation and public sector involvement is absolutely vital today to ensure a ‘fit for purpose’ (sorry Christian..) service. Leave the private sector in charge and they will simply take the path of least resistance to ensure the most amount of dosh flows in…..but the notion 17 years ago that a 100% private system can work alongside competition from air and road was well…suicide as subsequent events proved.

    I’m not saying that a hybrid public-private model can’t work (it does in other nations), but thusfar out of our two attempts (the London Underground PPP and the 1993 Railways Act), one has already failed and the second is eventually going to implode on itself.

    On the subject of buses and the mentality of bus companies – where an MOT and a fairly rudimentary monthly check-up is all that’s required. There is none of the strict regulations underpinned by legislation that govern railway rolling stock in how it is procured, acceptance tested, and then maintained and checked throughout its life. And how many buses apart from London Routemasters do you see having mid-life revamps? No, they get kept until the paint (and rust) is all that’s holding them together usually. Perhaps then we should be thankful that the ROSCOs actually own the stock and I imagine that it is a condition of the lease that the lessor performs all the necessary inspections.

  • Anoop

    I think that the trains, track and associated infrastructure are so tightly associated that it is best for a single organisation to be responsible for them within a geographical area. This can work whether the organisation is public (e.g. British Rail) or private (e.g. the British companies pre-nationalisation, modern railways of Japan).

    The fragmentation of our railway causes many inefficiencies. For example, train operators have no incentive to reduce power consumption by their electric trains because many trains do not have electricity meters. They may be deterred from using spare stock to reduce overcrowding because of excessive leasing charges.

  • Rhydgaled

    @Dan:
    My nearest bus stop doesn’t even have a pole! I suppose since the bus is running on a hail-and-ride basis it doesn’t really matter, the ticket machine does have the name of the road junction though.

    Anyway, further to my previous comment, I may actually have found a point of not having a nationalised railway (just one mind, verses the whole list of reasons the railway should be nationalised). The reason is this: the TOCs pay the track maintenance costs rather than the goverment (at present Network Rail also gets a grant from government to keep track access charges lower than they might otherwise be) but this could free up some goverment money for enhancement and extension projects. However if there were no ROSCOs and the goverment owned the stock and allows the TOCs access to it (with the TOCs paying all or part of the train maintainance, staffing and fuel costs) maybe Network Rail wouldn’t need that grant to cover part of the track maintenance costs, maybe the TOCs could even manage to reduce fares if they got their stock leases free.

    Another question has recently surfaced when I was given a figure of £1.7m subsidy for the WAG express from Holyhead to Cardiff and return (just the one working every weekday). If this service (which was quite well loaded when I traveled on it in the northbound direction as far as Crewe) would make that big a loss without subsidy how is any TOC able to make a profit? I was also told a decent service to Fishguard would require in the region of £3m subsidy. With costs like these it sounds like the TOCs would have to run every service packed to the rafters with passengers lying on top of each other just to break even, so how can some franchises afford to pay premiums to the department of transport?

  • RapidAssistant

    To answer your question Rhydgaled there are a number of points:

    The profit making franchises are, by and large the long distance inter-city operators. That’s because they have a first class, and fare revenue is on balance, higher. They can also generate ancillary revenue through catering, and commission via linking to things like hotel and car rental booking through their websites. This is nothing new – apart from freight, the most profitable part of British Rail was InterCity. The Beeching cuts were also predicated on the basis that the main line traffic was the only profitable part of the railway – hence the mass closure of branch lines, and at the same time large scale investment in electrifying and modernising the WCML, the development of the APT and HST and so on.

    What BR did of course was cross subsidise via using the profits from InterCity and freight to prop up the loss making remainder of the network. Hence this minimised the subsidy required from government. The franchise system tries to mimic this through the premium payment and cap & collar arrangements, but of course there is the added dimension that you now have private sector involvement which means an ‘artificial profit’ needs to be creamed off the revenue/subsidy to make it worth their while.

    Remember also the London commuter franchises too, make money because the users of those lines simply don’t have an alternative due to the punitive costs in both time and money of trying to drive into the centre of London. The result – (excessively) high load factors and high fares from a captive audience – a licence to print money effectively.

    There are other factors over why costs have escalated so much – a combination of having to pay this “artificial profit” to the private sector, and that wages and salaries have gone out of control (some long distance train drivers are earning as much as airline pilots now, for a job that doesn’t require anything like the level of qualifications and training) – and of course the aforementioned Network Rail inefficiency and gold plating.

    Going back to your original point – it is these factors why even a seemingly well loaded service still runs at a loss.

  • Dan

    Rapid – interesting point about Net Rail gold palting – as many people mention. I was not long ago in France – and one of the most noteable differences to my eye was the way that the SNCF system – even on soem minor lines – does not have the all pervading air of neglect so common in the view from a UK train (weeds everywhere, buddlie sprouting from every building, bridge and tunnel, cutting retaining wall etc), not to mnetion run down and decrptid stations and the ‘bus shelter’ provision at many minor locations. I’m not syaing Net Rail is dangerously un-maintained – I don’t think it is – but this difference does give an indication of the level of pride in your assets that the owner takes. What would anyone think about a street of houses that looked in equivalent condition?

    Take alook at this rail / cycle interactive map where a click on any station gives a range of pics of the station area – and mnay of these are in remote parts of Brittany – but the quality of presentation is higher than most UK TOCs would achieve

    http://www.carte-velo.sncf.com/carte_bretagne/flash/bret_velo3.html

    Hope this fits in with and appeals to Christian’s recent continetal cycle themed break!

  • RapidAssistant

    Dan – reading Nigel Harris’ editorial in the latest RAIL, it is frightening to think that the idea of reprivatisation of Network Rail is even being considered. Apart from the whole bonus debacle, there is the ludicrous fantasy land economics that they can somehow pay off a £23bn debt from assets that would struggle to make over £10bn. At the same time the ‘book value’ of HS1 is chicken feed in comparison to the kind of sums being mentioned.

    Are they seriously considering creating another Railtrack?? Surely not! But as I’ve said in previous threads, no Tory minister would dare utter the N-word. But yet another attempt to sweep this debt under the carpet in a vain attempt to try and make this structure work is only going to end in failure once again.

    But going back to your point about SNCF; I am loathed to admit that selling the family silver to Johnny Foreigner to the likes of the French or German state railway companies might be the hallowed ‘third way’. Maybe they can do to our network what decades of political meddling and short termism have failed to do here in Britain.

  • David

    There are two factors we have to remember here. Firstly, a company exists to make a profit for its owners, and secondly, every contract price tendered by a privately owned company will have both profit and contingency elements built into it.

    So in a structure so complex as has been created in the UK, it doesn’t really need a committee of inquiry under the leadership of Sir Roy McNulty to determine that it is a combination of private ownership of TOCs etc, the status of Network Rail, and the organisational structure itself with all of its contractual relationships, which are the major causes of the cost increases which have at last been recognised by the DfT.

    Moreover, we have to remember the good old Common Law principle of damages – in “railway speak”, compensation payments. So, simply, whenever Network Rail interferes in some way with a TOC’s train services, it has to pay compensation; those project costs in the public domain indicate that a substantial element of the costs of each project are as compensation to those affected in some way whilst Network Rail was “interfering” with their services, even though they will probably benefit from the works once completed. And, of course, if one TOC interferes with the operation of another, it too has to pay compensation payments to the TOC which has suffered the inconvenience.

    We are all being lectured by our present government on the need to be prudent. How it reacts to our railways will be a test of their seriousness, for if they put politics first we are unlikely to see the major changes that are necessary to the railway structure to drastically cut costs; but if they admit that the Conservative government of John Major got it badly wrong back in the early 1990s and re-create a unified system, then many of the costs presently being incurred would automatically fall-away. And then if they restored the railway system to public ownership (which, I believe, is very unlikely, although I would personally like to see it), the profit element essential if they are to remain in private ownership would also fall away.

    I look forward to what McNulty has to say. I hope he will be brave and honest and point out the weaknesses of the present system and state how they can be easily eradicated, in so doing giving the country a far better rail network at much lower cost than presently incurred by both users and tax-payers, but I’m not holding my breath; I guess another Serpell is the most likely outcome, but I hope I’m wrong.

  • RapidAssistant

    The dilemma about renationalisation is twofold – firstly you would want to recreate an independent agency separate from Government to run the network, and end the wasteful micromanagement by the DFT. That would be a British Railways Board, in effect – yet in doing so would be creating a “quango”, at a time when quangos are rapidly going out of favour. Secondly you have the rail unions – where you have Bob Crow and his ilk puportedly supporting a publicly owned network on behalf of the travelling public, but down below have the real interests of their members at heart. Privatisation perversely empowered the railway unions, and how would the relationship change if we were to go back to a state owned and run network?

    But I honestly believe another Beeching/Serpell is unlikely. The overall political climate and antagonism against the railway that existed then simply doesn’t exist now. In an era where every other major economy in the world (most importantly the USA) is now either building or planning new lines, it would be not politically tolerable to even tout the idea. The very threat of it however would serve as a good “warning shot” for people to stand up and take notice that the industry is in desperate need of reform.

  • Ian Raymond

    Maybe not Serpell Mk2, but I would have thought there’s got to be a risk of losing more of the ‘softer’ side of things – I’m thinking here pretty much anything which is highly useful for current passengers but only used by small numbers – the rump Sleeper network and Blaenau branch for example… ‘trimmings’ rather than ‘cuts’.

    Watch out also in case the old cynical ploy is used; announcements of possibly much wider cuts so that then when only small parts of operatins are pruned, the PR gloss paints the closures as “good news, considering”…

  • RapidAssistant

    Re. sleepers – I can see the Night Riviera being binned as both the economics and the rationale behind keeping it are distinctly ropey.

    When it comes to the Scotland sleeper – the Lowland Glasgow/Edinburgh service I think will prevail as it is well used by business travellers, since it allows for a 7am arrival in London without having to leave home at crazy hours of the morning to get the first flight of the day. In fact it should be strengthened by doing away with the Highland train (to Fort William/Inverness/Aberdeen) altogether, run an additional Lowland service and making people connect north of the central belt using local services.

    Then I recall the Fort William sleeper the last time it came under the cost cutting radar (ironically, under British Rail) , which was saved by the deerstalking lobby (mostly hardcore Tory supporters, of course) who relied upon it every September…..

  • Ian Raymond

    Should hold my hand up here – was definitely one of the “deerstalking lobby” protesting against cutting the Fort William back in the 90s… (tho certainy not a hardcore Tory supporter) – more an avid hillwalker and this is the only way to reach the area without wasting a full day’s annual leave travelling each way!

    It certainly doesn’t make economic sense (or from a carbon emissions per person point of view an environmental one either), but even on a midweek in Winter it is still very well used – sometimes it’s been too full for me to book a space – unlike Inverness + Aberdeen the ‘Westies’ don’t have an air alternative. But Ive got to be honest – can’t see it lasting, when far more well-used Museums + other services are facing such cuts.

    Presummably the purpose of such short sharp cuts rather than a more gradual process is so that the incumbents can present a softer face in time for the next election…

  • Dan

    Cut backs on sleepers would be disastrous (and Cornish one is very important given the absolute paucity of services to the west), Plymouth must have one of the worst arrival times from london for a regional city – made worse by the dropping of the carriages for Plymouth to save shunter costs presumably.

    Remember the Lib Dems have most of their seats in these Highland and SW fringes. Cuts here would put them under pressure on their patches and bear in mind they will soon see their seats being eroded as people get fed up with them supporting the govt, so they may resisit high profile cuts.

    Cost savings from sleeper cuts would be marginal until the Mk3 SLEPs need replacement – at which time you could probably buy some spare ones from Canada that are in loading guage….hang on a minute – who paid for them and what were they originally built for?….shome mishtake shurely…

  • RapidAssistant

    Well – given that the SLEPs only do one 400-500 mile journey six days a week (the Cornish sleepers even less so) it will be a while before they catch up with HST coaches that may do two London-Scotland diagrams in a day, it will still be a long, long time before they are worn out, so we needn’t worry!

  • Chiltern User

    To return to Christian’s main theme in the 2 July ‘Rail’ column, franchising, the phrase ‘in special measures’ to describe the status of several franchises which are being shored up by the DfT is well-chosen.

    I hope that comparing TOCs to poorly-performing schools which are subjected to tight inspection and scrutiny will reach the wider press and MPs. A few uses of the term in Hansard once Parliament resumes could focus attention on the rickety state of franchising.

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