MR BILL EMERY, MR MICHAEL BESWICK, MR BRIAN KOGAN, MR MARTIN STANLEY, MR JOHN BANFIELD

19 JULY 2006

  Q360  Mr Scott: Do tight franchise specifications make companies risk-averse? That is for anyone.

  Mr Emery: I am not saying there is an automatic link. What tight specifications do is to limit the options that are available to respond to the market and in a sense you create a lot of barriers to responding to the market place, and that is where some of the difficulties are. There is an issue about what the franchising process is about; it is about selecting the right player and then it is about getting the right specification, and you could say that there is a little bit of a question mark in some of these things that they join up those two things and then they do not go on and look at a more flexible specification.

  Q361  Mr Scott: A question for the ORR. You appear to indicate that the government is too preoccupied by the objective of minimising subsidy or maximising premiums. Could you explain the position more clearly, please?

  Mr Emery: Certainly the government has a very legitimate role in seeking value for money from the railways, and in the sense of pursuing the best franchise bid for the services that it wishes to buy then it has done exactly what is right. What I think it does, it gets back to the point of saying that there is a tendency then to assume that the full benefit arises from just during the franchising process and not allowing the flexibility, it having got there, for the franchisee then to respond to the market, and barriers are put in that make it more difficult for the franchisees to respond to the market. The incentives in the system are such that the franchisee has little incentive, working very closely with Network Rail, to reduce Network Rail's costs, because in fact the way the risk allocation plays out the majority of risks are carried by government and that again presents a marginally sub-optimal way of running it, although the testing regularly of what is the best franchise is a way of getting value for money at that time. The question is open. You are going out with a franchise bid and yet it is running for a period of seven years or longer, it is very difficult to be able to forecast what the market needs over that period of time. You lock that in too much and if you do not give the franchise companies full incentive to operate and cooperate with Network Rail then you are losing something. This is an area we want to explore with the railway industry as to better ways in which we can align incentive, as I said at the beginning.

  Q362  Mrs Ellman: How can you get more entrants into the franchise markets, or do you think that is necessary?

  Mr Beswick: I think it is always desirable to get new entrants into the franchise market. I think the thing that you have to do is to make the franchise proposition attractive to a wide range of different players, and you may well find that different companies like different sorts of franchises. Some of them will like a franchise that is very heavily specified, the sort of thing which you might have in a PTE area or something like that, and others will want to have franchises where they have more chance to innovate and take risk. I think probably the most important thing is to have a franchise offer that is targeted on the sort of railway that may be a bit different for some of the franchises.

  Q363  Mrs Ellman: Are you aware of any specific obstacles impeding access?

  Mr Beswick: In terms of impeding new entrants then clearly the cost of bidding is always a serious consideration, but there will be a cost in bidding. Clearly a part of that which I know we are all concerned about is that if they have to go through the procedure of competition clearance then that again is another cost, and I think we are working with the competition authorities and the Department to ease that.

  Q364  Mrs Ellman: Are there any other observations on that? No. Would it be better to have a one-stop competition authority instead of having the OFT and the Competition Commission in respect of rail issues?

  Mr Stanley: Would you like me to take that?

  Q365  Chairman: Shall we get rid of you is what we are saying, in the nicest possible way!

  Mr Stanley: The difference between the Office of Fair Trading and ourselves is that they take a first look at a wide range of issues, a wide range of mergers—they might look at 200 cases a year. There always, whether you have a separate authority or the same authority, has to be a second stage where the problem is identified and somebody has to do a really heavyweight job and a really proper deep economic analysis before you can stop a merger happening or permit it. In Europe, in the States it is done within the same authority within a two-stage process; here we happen to have two different authorities—an advantage or disadvantage I guess in different places. But it seems to work here. I think the cost of changing would be quite large.

  Q366  Mrs Ellman: Can I ask the Competition Commission, what proportion of all bids is referred to you?

  Mr Stanley: Franchise awards or mergers more generally?

  Q367  Mrs Ellman: Both.

  Mr Stanley: The Office of Fair Trading look at around about 200 maybe a bit more mergers per year, including the number of rail franchise awards.

  Q368  Chairman: Sorry, is that 200?

  Mr Stanley: 200 or slightly more, perhaps. Of those we normally get to look at around 15 mergers so we would look at the London Stock Exchange, Waterstone's/Ottakars, those sort of famous cases. Rail awards, I reckon we get the majority but not all of them, by any means.

  Q369  Chairman: It is an affirmative nod there. Mr Banfield?

  Mr Banfield: We have had five references since 2002. There are obviously some franchise bids that have not come to us such as the integrated Kent franchise or Trans-Pennine, but we probably do the majority.

  Q370  Mrs Ellman: Would you say that it is sensible to consider the awards of the franchise as being the equivalent of a merger?

  Mr Stanley: Whether it is sensible or not, it is the law first of all so we cannot avoid it.

  Q371  Mrs Ellman: Is it sensible now?

  Mr Stanley: Yes, I think so because there are a lot of implications as a lot of these companies own local bus routes, local coach routes and somebody has to defend the consumer and look at that particular aspect of it. The Department for Transport has enough on its hands without employing a large number of lawyers and economists to carry out that sort of analysis. So I think it is quite wise to have a separate authority look at that aspect of an award.

  Q372  Mrs Ellman: Do you think it justifies the expenditure? Is there not a simpler way of doing it?

  Mr Stanley: These cases are quite complicated. It used to be five or six years ago that mergers were dealt with in a quicker and less expensive way, but these days with us taking our own decisions and companies wanting a fair hearing and wanting to argue they themselves have good lawyers and good economists and it all gets rather expensive. But at the end of the day the process is a very strong one and it is well respected, which I think is important.

  Q373  Mrs Ellman: The train operating companies tell us that it costs around £1 million to go through your process. Is there any way of reducing that cost?

  Mr Stanley: It is quite hard to given the depth to which we have to go into these things. Something like the Great Western Franchise that John Banfield looked at, involving a huge number of different flows covering the whole of the West Country, you have to do a lot of analysis of what would happen where in Bristol and on other routes in terms of passengers switching between bus and coach and rail if prices were to change, and it is a very deep process, but it is also a good one. Most people are happy if the end result is they get the permission, which they did in this case.

  Q374  Mr Leech: Mr Stanley, you made the very interesting comment, you talked about buses, coaches and trains but you did not mention cars. I think one of the concerns raised by the rail companies is that their biggest competitor is the car and certainly I would strongly agree with that. Do you not take that view?

  Mr Stanley: It is a perennial debate. John you are the expert on that.

  Mr Banfield: This is an issue on which we regularly disagreed with the companies. There is a lot of research on demand of the use of public transport and what is called the price elasticity of the demand and the extent to which you could put your prices up because if you put your prices up by 10%—

  Q375  Chairman: A little louder I think, Mr Banfield. Have a heart because we are writing a record!

  Mr Banfield: Broadly, if you put your prices up by 10% does your demand go down by 10%? Do you make any money or not? A vast amount of research does suggest that demand for public transport is inelastic and it is profitable to put your prices up, so the competition from the car is not an effective competitive constraint, at least in the short term.

  Chairman: Mr Efford.

  Q376  Clive Efford: The train operating companies have told us that going through the full Competition Commission process can cost £1 million. Why is it so expensive and is that in the public interest?

  Mr Stanley: It is expensive because we do a very thorough job. We ourselves of course do not charge them anything, we employ our own economists and our own accountants. In order to combat the clever people like John Banfield on my right and all the other teams the industry chooses to employ very expensive consultants and very expensive lawyers and to do a lot of research and put in a lot of data and it costs them a lot of money. I cannot control that cost; we just do the best job we can and a fairly thorough job, and in response they choose to spend that money.

  Q377  Clive Efford: So the charge that these costs are imposed by the strictures that are imposed on them to satisfy the procedure is not a fair one?

  Mr Stanley: Obviously they feel it is a burden and indeed it is, but the choice of whether to spend half a million or three-quarters of a million or a million is very much their choice, depending on the depth into which they wish to go. If the end result is that they get allowed, as they usually do at the end of the day, having put forward very persuasive arguments, if at the end of the day they not only get the franchise but also get the competition clearance they probably on reflection think it is good value for money.

  Q378  Chairman: That is actually quite an interesting point, but you have not blocked any awards and you have only imposed conditions in one case since 2002.

  Mr Stanley: Indeed.

  Q379  Chairman: But you looked at seven bids through five separate referrals all at very considerable cost, as we have heard.

  Mr Stanley: Yes.