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.

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