DEREK TWIGG, MR MARK LAMBIRTH AND MR ROGER JONES

19 JULY 2006

  Q460  Clive Efford: Let us go through a scenario. If there were a downturn in the economy, and the profitability of the rail franchises is very much reflected in employment and the performance of the economy, and a rail franchisee came back to the Department and said, "Look, we just can't make ends meet," would you renegotiate?

  Mr Lambirth: We would have two types of TOC in those circumstances coming back to us. There is the one that has a new style contract with revenue risk sharing mechanism in place, and we would say, "No, we're sticking to the letter of the contract." The whole purpose of writing revenue risk sharing into the contract was to address precisely that scenario. What we have said in the guidance on rail franchising that we placed on our website is that if in that sort of circumstance a train operator who was operating under an old-style franchise came to us, we would entertain the claim. You have to understand we have a negotiating position that we would be seeking to protect, but certainly we would take a case from them.

  Q461  Clive Efford: If I am First Group, a big, powerful player in the network, and I say, "You are exposing me to too much risk because there has been this downturn and there is not enough coming back through the fare box," are you seriously saying you are just going to sit back and say, "Tough luck, old son"?

  Mr Lambirth: Yes, because you have also heard from people who say that we have transferred too little risk to the train operating companies, that we have revenue risk sharing mechanisms under which, at the extreme end of the spectrum, we could be bearing 80% of the revenue risk downside and the TOC only 20%. They willingly entered into franchises on those terms, so yes, that is what I am saying.

  Q462  Clive Efford: We would be talking about parts of the network being significantly reduced, would we not? What would the Government's reaction to that be?

  Derek Twigg: In terms of the point that Mr Lambirth has just made, if they are in breach of the franchise, then that is a different matter. Then obviously we could take that off them and re-franchise.

  Q463  Clive Efford: There are two points here. There is one about the reaction to the position of a train operating company in a downturn in the economy. The other is, does the Department actually feel in any way intimidated by a large corporation that has a multiple number of franchises?

  Derek Twigg: No. We are very clear. We set up a franchise, it is clear what they have got to deliver, and we expect them to stick to that.

  Q464  Clive Efford: What about the costs of the industry? Why have train operators failed to control their costs in recent years, resulting in increases of 47%?

  Derek Twigg: Again, it is an interesting figure but none of us can actually determine where it comes from or how it is backed up with anything in particular. I think I mentioned in my opening remarks, Mrs Dunwoody, and it is probably worth reiterating in answer to Mr Efford, that if you look currently, the TOC fare box revenue is 47%, and of course, the passenger journeys have increased by 42% and passenger train kilometres operated is up by 23%. We are looking at costs of around 27%. So I do not think that is excessive in terms of what is happening on the railway. It is not in the interests of train operating companies to increase their costs. What is in their interests is to drive down costs but to provide a good-quality passenger service, which then attracts more passengers and therefore more income.

  Q465  Clive Efford: We have had evidence from Professor Nash that the figure we had for four years directly post Hatfield are that, having stripped out track access charges and payments to the ROSCOs, train operating costs appear to have gone up by 47% in real terms. You do not recognise those figures?

  Derek Twigg: We do not recognise them.

  Q466  Clive Efford: I was going to say "spiralling costs" but costs are going up and you have accepted they are going up. How do you intend to bring those costs down in future?

  Mr Lambirth: We are in danger of using "costs" in two rather different contexts here. When we are letting a franchise, we are not actually interested in what the costs of the franchisee are, although we are very interested in whether their cost reduction plans are realistic or in what their revenue is, though we are very interested in whether their revenue increase plans are realistic, because the price that they are bidding to us is the difference between the two. So if a train operating company looks at an opportunity and says, "Look, if I spend an extra £1 million on improving catering or recruiting extra revenue protection staff, that will generate £2 million of revenue" then they will do it and that must be in both their interests and ours. So we have no separate aim of controlling their cost line. We are very concerned about the gap between revenue and costs, which is what they bid to us.

  Q467  Clive Efford: The train operating companies have said to us that part of the reason that their costs are escalating is that Network Rail's costs are a significant contributor. Are we passing on Network Rail's costs to train operating companies and is it passing the buck?

  Derek Twigg: Network Rail have a clear target that they have to reduce their costs by 31%, and they are now on track to doing that, and I think they are getting better in terms of reducing the costs and being more efficient. You have to obviously take account of what happened in terms of the miles of rail track and what they had to pick up. Clearly, they need to continue to improve and, as I say, the target is a 31% efficiency saving and they are on target for that.

  Q468  Chairman: Do you not think it is odd that in the bus industry tendering has meant there have been very big reductions in operating costs, but in the rail industry franchising has coincided with great increases? Does that not suggest franchises have failed to deliver value for money?

  Mr Lambirth: Over time, our subsidy bill to the train operating companies is down, over a period when . . .

  Q469  Chairman: Was that not the original intention, Mr Lambirth?

  Mr Lambirth: Yes.

  Q470  Chairman: So you are not doing anything that you are not expecting to do. You are just telling us that you are doing what you decided to do in the first place?

  Mr Lambirth: Not me personally, but yes, the aim of privatisation was . . .

  Q471  Chairman: I do not hold you entirely responsible for the whole system.

  Mr Lambirth: Thank you. What we have seen is an increase in passenger numbers and a reduction in the subsidy bill. The bus market looks very different but, as I keep on saying, I think it would be very wrong for us to set out and have an objective of trying to drive down train operating companies' costs, to say we think that rolling stock leasing costs should be driven down by this amount, pay bill by that amount, or energy prices by that amount, because the whole purpose of franchising is to put a private sector company in a position where they are incentivised to maximise the difference between the revenue and the costs.

  Q472  Chairman: Yet we are eternally being told that one of the problems with the franchise decisions is that, when it comes down to it, cost is one of the things that is more important to you than the quality of service.

  Mr Lambirth: No. Price, not cost.

  Derek Twigg: Deliverability and price.

  Mr Lambirth: If you want to talk about the assessment of companies' bids, we are looking at two things: their proposition to us on price, ie the gap between revenue and cost, and their proposition on reliability, how much they would reduce delay when it is within their control; and then we also ask the question which Mr Twigg poses: are we confident that this is a deliverable proposition on both price and reliability?

  Q473  Chairman: Do you look at how other nations within the European Union handle their franchise system, for example, the Dutch?

  Mr Lambirth: We have talked to Anton Valk, who gave evidence about the Dutch system, but it is hugely different, as he will have explained to you. You have the provincial franchises, which are very small, and you have a single very large national franchise, which is the franchise that he operates out there. So yes, we have discussed it, but the regimes are so very different from those in the UK.

  Q474  Chairman: Yes and no, Mr Lambirth. It is not the greatest land area in the world, even if we take account of both the franchises that relate to the regional input and those that relate to the national input. The whole geographical area is not so large that one would have thought one could differentiate too strongly.

  Mr Lambirth: I think the point I am making is, if we had a single franchise which covered 80% of the railway network in Great Britain, then inevitably your approach to that operator would be different from the one which we pursue.

  Q475  Chairman: Do you think it is constructive to use different franchise models for franchises that can pay a premium and those that require subsidy?

  Mr Lambirth: I do not think we are convinced that there is a huge difference between franchises which pay premia and franchises which receive subsidy. In both cases we are setting the minimum level of service which we expect the franchisee to deliver, and I do not think that in either case it would be safe to allow the franchisee to determine what the service level should be, in other words, to have a reduction below the minimum which Ministers specified. The reason for that is that although a franchise may be paying a premium, that is not the same thing as saying that all of the services along that franchise are commercially viable. So in effect, we are asking the franchisee to provide services on there which are not commercially viable but which are judged by Ministers to be necessary.

  Q476  Chairman: Would you accept that innovative proposals that are contained in a bid could be disqualified from being part of the bid if they are not fully and formally compliant with all aspects of the technical specifications?

  Derek Twigg: That is part of the bidding process in terms of costed options, in terms of if a bid has come forward with innovative ideas for improvement in services . . . A classic example, I suppose, is that we looked at the sleeper service to the West Country, which obviously we talked about at one stage stopping, but the franchisee, the winner, felt they could continue with that and improve the service. So if they have an innovative idea or suggestion which obviously stacks up and we believe is value for money, then clearly it is something we will look at. I come back to the point, Mrs Dunwoody, that this minimum service level is what it is: a minimum. They are free within certain constraints, which I have explained, to come forward with additional proposals if they wish in terms of extra services.

  Q477  Chairman: Why is it that both the industry and the companies seem to be still confused about how straightforward and accountable, consistent, you are in setting and adhering to award criteria?

  Derek Twigg: I think that we have just taken over responsibility, as I said before, and the first franchise that we started basically from start to finish will be the South Western franchise, and I think you will see a number of improvements being made in terms of how we work with the industry, consulted on that franchise, and I think there is much more clarity in that.

  Q478  Chairman: How are you held publicly accountable for your choice and application of criteria for franchise winners? The Department, not you entirely.

  Derek Twigg: I am not quite clear in terms of what you mean, Mrs Dunwoody.

  Q479  Chairman: It is said that we have very little underpinning evidence in the public domain as to the rationale used by the awarding authority.

  Derek Twigg: We have published on the website information about how we do that. Certainly in the franchises that we have started, the South Western franchise, and we are continuing at this present moment in terms of the West Midlands, East Midlands and Cross Country going through extensive consultation meetings with stakeholders in those particular areas of the country, discussing in quite some depth and detail. So I think there is quite a lot of work going on. It may be that is caught up in the issue around the Great Western franchise, where there are issues about the consultation and how that was dealt with, but clearly, the franchises we are starting as a Department, that has changed.