INTRODUCTION

  1.  This submission has been prepared in response to a request to do so as a practising consultant in the field. I have appeared before the Committee before, to answer questions on matters related to franchising, on behalf of the Strategic Rail Authority.

  2.  As a founder and Director of Steer Davies Gleave, I have been engaged as an adviser to the British Railways Board and its constituent business prior to privatisation and subsequently to various parts of the privatised railway "family". My own experience covers franchise bid advice to management buy-out and corporate investor teams, and ongoing support of operational franchises. I was seconded to the SRA for a period of three years and three months from 2002 to 2005, as Managing Director, Strategic Planning. I took a pre-agreed three month break before returning to Steer Davies Gleave in October 2005. I am also a Director of Greengauge 21, a not-for-profit organisation that seeks to advance the debate around high-speed rail for Britain.

  3.  I have participated therefore in various aspects of the privatised railway with the benefit of having also been involved in a number of important developments in the BR era. I set out some views on these matters at conferences and in journals.[3] In 1992, I wrote a report for Transport 2000 entitled "Costs of Rail Privatisation". This foretold increases in the overall costs of rail provision, in part because of the increased costs of transactions between the various industry players. This indeed turned out to be the case, although I believe that there are a number of benefits that can and should be set alongside the additional costs of rail provision today compared with 13 years ago, most of which are unrelated to the structural changes in the industry in my view.

  4.  I shall restrict myself to the specific questions in which the Committee has expressed an interest. The opinions here are my own, and they may not be those of my employer Steer Davies Gleave.

THE PURPOSE OF RAIL FRANCHISING

  5.  The rather fundamental first question posed by the Committee is: "what is the purpose of passenger rail franchising?" and then, "is the current system achieving that purpose?"

  6.  The purpose of passenger rail franchising is, in my view five-fold, as it has turned out:

—  To create entities and managements that can be closely focussed on meeting customer needs in an operationally complex system [the railway] where technical, operational and engineering considerations have a natural tendency to dominate.

—  To introduce a managed level of competition into train service provision, avoiding the uncertainties and therefore costs associated with an on-track open access type of competitive environment, yet still deriving the benefits of competitive pressure as a means of delivering value for money to the public purse.

—  To introduce fresh ideas and a diversity of ideas on how best to deliver quality and value for money, removing any dependence on a single centrally determined prescription, and offering the prospect of a learning-from-rivals culture to achieve best practice.

—  To create an ability to measure and incentivise performance and performance improvement and provide the means to bench-mark.

—  To achieve an objective of successive Treasuries, which is to contain public sector spending, and in this case, specifically to keep the capital elements of passenger train service provision costs off the public sector accounts. In relation to rolling stock, this is generally achieved through franchisees' use of ROSCOs for the supply of trains on a leasing contract.

  7.  I am not suggesting that these were necessarily the objectives at the outset, in the minds of the authors of the rail privatisation model. But these are identifiable purposes that franchising has brought, that would potentially be lost without it.

  8.  The proposition of a separate entity focussed on customers was a feature of the thinking behind the "sectorisation" of BR brought about under Sir Robert Reid in the early 1980s. Indeed, the contractual structure of franchising, in theory, ought to deliver what I recall senior BR managers at the time were hoping to achieve: a commercial approach, customer-led, and able to determine the standards to which the critical and expensive technical and engineering components should be supplied. That would have been in the public sector and under a single management structure of course. But my point is to distinguish the first of the three objectives—an alignment with customers' interests—from the wider debate about the merits of privatisation per se, with which I suspect it is frequently confused.

  9.  As to whether these purposes are being met, I would answer as follows. As to the first purpose, I would argue to a very significant extent that this is being achieved, day-in day-out, remembering that the alternative is an un-franchised structure under some kind of command and control management system. Comparisons across the decades are hard to make empirically in this field, but it is certainly the case that the level of attention to customers on today's railways by the franchisees is immeasurably much greater than it was in the latter days of British Rail. That isn't to say that performance in this area couldn't yet be made very much better still: surely it could be. But the growth in rail passenger use would not be continuing were rail not offering a better travel solution than its competitors.

  10.  With regard to the second purpose, I would also suggest a significant level of achievement. This can be empirically tested up to a point. Certainly, the market for rail passenger franchises is well established, with major UK listed companies regularly contesting the market, and a number of off-shore companies involved too. DfT and the SRA before it have had no apparent difficulty in attracting bidders. It is a competitive environment, with bids offering the prospect of significant savings to the public purse. The problem is that in some cases, these remain just that—prospects, although in general it is the case that franchises are continuing to deliver against agreed declining levels of subsidy, albeit that the overall levels of subsidy are higher than in BR days.

  11.  The fact is, however, that there are good reasons why costs (as well as revenues) are higher than in the BR era. These are (1) the railway is a lot busier, carrying many more passengers (2) it is operating at a higher level of passenger safety and this comes at a price (although quantifying this price is extremely difficult) (3) there has been inflation over the period since the demise of BR, including in specific areas such as pension costs (4) the railway has been going through a period of catch-up on renewals. The last-mentioned in particular applies to Network Rail, and this is reflected in a significant increase in track costs, with, for example, franchisees using the West Coast Main Line which has been the subject of a major renewals programme passing on very much higher track costs to DfT than they started with. In these circumstances, in an industry where there is a mix of premia and subsidies for franchises that sum to a net cost (subsidy) as far as the exchequer is concerned, it is not surprising that cost increases exceed revenue growth. A worsening over time of "franchise" economics may mean several things: it doesn't necessarily mean that franchising is offering poor value for money compared with the alternatives.

  12.  Value for money is at the heart of this second purpose. I am not aware of any research designed explicitly to prove the point either way on the role of franchising in this context. To do so would require definition of what economists would call the "counter-factual", in other words, what is assumed to exist in the absence of franchising? This cannot sensibly be "just turn the clock back". Rather a contemporary arrangement would have to be defined. It would seem rather likely that such an arrangement would have a significant degree of decentralisation (after all, the initial franchise definitions followed BR's "sub-sector" boundaries), ie key components would be contracted out. This could probably only be done under law by a competitive tender. So the distinction would presumably be about ownership and whether the relationships are contractualised, rather than on the scale and nature of the business entities (leaving aside the rather separate question of the virtues or otherwise of so-called vertical integration). There was a good argument to be had at the time of privatisation that a preferable solution would lie in the retention of a central contracting entity (BRB), with separate businesses hived off. The passenger rail service companies would have looked remarkably similar to today's model. The difference would lie in the nature of the contracting authority and its ability to direct coherent behaviours. The notion of track access "rights" which franchisees regard as a principal asset would not arise. But, as noted, no such study has to my knowledge been carried out and there would be little purpose served in doing so unless there was a clear consensus around an alternative model or models.

  13.  A further factor in the value for money equation would be the question of whether or not the private sector businesses that have acquired franchises have brought in skills previously lacking in the rail sector. While it would be judgemental to argue the relative virtues of the management skill-set between the public and private sectors as a generality, it is certainly the case that the new owners have challenged many assumptions that previously would have been taken as fixed. I would argue that they need to go further and in particular to establish a means of engaging in industry-wide developments more effectively than has been possible so far under the aegis of ATOC.

  14.  The third and fourth purposes are straight-forward, secondary but of significance. Franchisees have tackled challenges differently and broken various "moulds" of behaviour. I would cite the fresh approach to contracting for the supply of rolling stock, with some franchisees opting to procure the provision of rolling stock, their maintenance and the supply of new depots through a single integrated contract with associated tariffs and performance incentives as an example. It is far easier to test out new ideas dependably if they are attempted locally with a committed management effort (rather than as a nationwide programme) if the overall outputs are tightly specified in a franchise agreement. There has been a welcome diversity of ideas brought to the railway, much of it not particularly visible to commentators, because the innovations tend to be at the routine or management level.

  15.  When franchising commenced, the only data made available for public consumption on a regular basis was a set of monthly performance statistics, franchise by franchise. Newspaper editors then had the pleasure of publishing league tables, with nobody bothering to explain that some franchises were very much easier to run reliably than others. Nevertheless, these statistics proved ultimately to be a significant influence over the owners and managers of the rail franchises. Performance reliability became a driving policy for the industry, with the very public exposure of data against the names of major plcs I suspect an important factor.

  16.  The fifth purpose is about the public sector accounting treatment of capital expenditure on passenger rail service provision. It is intimately tied up with the issue of risk transfer. A move away from franchising that left government able to "interfere" in day to day management, including in capital expenditure would, I suspect, trigger ONS interest. The current arrangement has the characteristics of PFI, with the ability to have private sector management and financing of investments by franchisees, although usually not on the scale that has sometimes been hoped for.

  17.  Overall, while the value for money question cannot be fully answered on the basis of the evidence available, there is sufficient here to suggest that the purposes of franchising, as I have identified them above, are, to at least a reasonable degree, being fulfilled.

THE PROCESS OF AWARDING FRANCHISES AND THEIR DESIGN

  18.  I believe that the processes for awarding franchises have been exemplary. I am not in a position to comment on the smoothness of the transition from SRA to DfT, but I understand that similar approaches are being followed—and many of the specialist personnel transferred across.

  19.  There is a full consultation on the proposed "design" of the franchises with stakeholders and passenger group representatives. When I was at the SRA, I was responsible for the creation of an industry planning framework into which franchise specifications were intended to be embedded. This process provided the key links, with appropriate feed-back/up-dating along these steps:

Strategic plan-->Regional Planning Assesment-->Route Utilisation Strategy-->Franchise Specification.


  20.  Thus the franchises are not set in isolation, but by reference to wider industry plans that are designed to reconcile inter alia conflicting demands on a constrained network. This sequential process has yet to become established, although each of the constituent parts has been continued under the revised industry arrangements following the demise of the SRA and should become so in due course. The Strategic Plan was intended to be an annual document; the high level output statement (HLOS) process with associated statements may serve as its successor.


  21.  An important feature of the franchise award process has been the existence of two dimensions along which the franchise bids can be placed and valued. One of these is price; the other in effect reflects critical quality and delivery capabilities. The existence of the two is essential, in my view. Clearly, it is easier to measure a bid along the price axis. If departmental budgets are under pressure (and they always are) then there might be pressure to focus unduly on this most measurable output. I have no evidence that this has happened, but it is a risk and perhaps a greater one with responsibility for the process of franchising having been transferred from an agency into the Department.


  22.  The tighter specifications for franchises originated by the SRA and continued by DfT, are important here. Without this clarity, fair comparison of bidder responses other than on price is much harder, and can take the focus off the important area of delivery. It also reduces bidder costs, but means there is less innovation.


FRANCHISE SIZE, TYPE AND LENGTH; RISK ALLOCATION AND CONTRACTUALISING IMPROVEMENTS

  23.  The Committee asked questions here about the criteria and processes for determining these key franchise parameters, for the rather separate question about how franchise bids are evaluated (which I have addressed in answering the previous question-set), and the related question of whether franchise holders deliver value for money throughout the duration of the franchises.


  24.  The original arrangements on franchise length are well-known. The norm of seven and a half years was an attempt to strike a balance between, on the one hand, longevity so that the consequences of actions would bear on the incumbent and, on the other, frequent re-tendering from which the advantage of competitive pressure would flow (but which impose higher transaction costs on the industry). Exceptions were contrived for some franchises where there were significant investment programmes.


  25.  In the early years of the shadow and full SRA, an attempt was made to let longer franchises, but this was in the Hatfield era. The extension of journey times and appalling levels of punctuality meant that no bidder could be confident on revenues, and the longer ahead they were asked to contemplate, the greater the level of commercial commitment and risk involved. Given the state of Railtrack's finances, it was very difficult as well to commit the investments which it is frequently supposed might have helped justify longer franchises.


  26.  It was therefore necessary to adopt short term franchises for a period, since to do other than extend them until such time as an open competition could be held in a more propitious market-place, would not represent best value for money. Other franchises where a lengthy franchise term had been contemplated were the subject of shifts in bidder positions that rendered them poor value for money, so franchise length was curtailed.


  27.  It has often been said that long franchises are necessary to encourage investment. In practice, it is not the franchisee's finance that is of relevance here so much as their contractualised commitment and capability to deliver not just a continuing service but also a proven enhancement. The problem isn't having sufficient franchise duration to earn a return on capital (there are mechanisms available to cover off the miss-match between pay-back periods and franchise length) the issue is about having sufficient time to plan and undertake what often are complex programmes of work associated with making improvements in rail service provision. For example, Chiltern Trains was widely commended for making investments in its original formulation as a "short" (7Ö year) franchise. Indeed its competency in investment management was probably a factor in the award of a lengthier second term franchise. Chiltern happens also to be a franchise that has provided some finance as well as management of investment. Franchise length is not as critical to making investments as some people seem to imagine. The evidence for this is that "investments" of over £100 million are being made under "short" franchises. Major investments in infrastructure and new trains are not financed directly by franchisees, as a rule.


  28.  Franchise length is also a matter of EU law.


  29.  The question of franchise size has been driven by four things:


—  Commercial and operational coherence, defined by the market served (intercity, regional or commuter) and the physical configuration of the network.

—  The benefit of continuity (including onwards from BR's devolved management structures).

—  The economics of the franchising process which do not help the case for small franchises.

—  The desire to reduce complexity on the railway, including the number of contractualised operational interfaces. This led the SRA to develop a means to reduce the number of franchises, a process that is still in hand.

  30.  The Committee raises an interesting question about the latter period of franchises, and one with which I believe there has only been moderate success in a policy sense. It is difficult to plan as confidently and therefore to contractualise actions in the latter stages of franchises compared with the early years. There is a tendency therefore to see less initiative being taken further into a franchise term. However, it is also the case that perceptions matter, and in the lengthy run-in to the award of successor franchises, it can obviously be in the interests of the franchise owners to put on a "good show" if at all possible. While this may drive up the bench-mark standards that the tendering agency is likely then to set for the successor, these standards apply to all bidders: they make it harder to perform the successor franchise obligations but they do not harm incumbent bidder prospects. The introduction of major reviews into franchises also helps address the problem.

  31.  On the question of risk allocation, there has been an interesting change with the introduction of floor and ceiling thresholds after the first few years of the franchise. These are designed to address the risks that lie totally beyond the control of the franchisees, and yet could blow a franchise off course. The value of this policy shift should be experienced in the acceptability of tighter profit margins.

  32.  Improvement through the life of a franchise is the subject of various contractual levers. Usually, performance reliability measured by PPM will be set on an upward slope. Investments, even of a major nature have been deployed in franchise agreements. The unique experience of the West Coast project does not prove that these cannot work. Indeed, the contractual obligation on Virgin Rail Group is arguably the reason why a solution to that project's problems had to be found rather than allow the industry to simply "give up".

COMPETITION, OPEN ACCESS AND VERTICAL INTEGRATION

  33.  The industry track access arrangements are designed to facilitate a mix of open access and franchised operations. Most open access operations are freight. The problem to which the Committee refers concerns open access passenger operations and is the subject of legal action between a franchisee and the Office of Rail Regulation. I do not propose to comment on any matter related to this case.

  34.  What I would say is that the process described in 19 above is of some relevance. It entails the production of Strategies, and these Strategies the ORR was obliged to take into account in its consideration of track access applications, including from open access operators. Following the demise of the SRA, this is no longer the case and the ORR no longer has any such obligation.

  35.  This is most unfortunate, since the "light touch" coherence to industry plans that the 19 processes were intended to bring relied on this regulatory connection to ensure that the coherence achieved was given expression through the difficult decisions that the ORR faced on track access matters. While the Route Utilisation Strategies being taken forward by Network Rail are widely regarded as being very worthwhile, it cannot be for Network Rail (which has a duty not to discriminate between customers) to come to a view on how to handle the choice between open access and franchised passenger operations.

  36.  The Route Utilisation Strategies need to have an input from those responsible and accountable for rail industry funding, which is now the Department for Transport, that extends beyond any over-arching statement of policy to make explicit, in the circumstances of each route, how it wishes to see the particular issues of open access passenger services handled. Moreover, the Office of Rail Regulation needs to be able to have sight of the Route Utilisation Process (which it has) to ensure that this government input has been properly reflected and discharged by Network Rail so that it is in a position to align its subsequent individual track access determinations with the agreed route strategies. I would argue that ORR should be obliged to reflect these strategies in its decisions, and that such a position cannot be said to undermine its independence. If this is the counter-argument, however, then based on what I judge will deliver the best service to the public for a given level of public sector £ support, I would sacrifice some of the independence of the Regulator in exchange for greater coherence in the way that passenger rail services are planned.

  37.  This does not mean that there can be no open access operations, merely that they need proper thought and planning just as is the case with franchised services. The concept of planning does not fit easily, without this wider apparatus I have just described, into the essentially reactive processes that the ORR undertakes. It requires the contrivances I mention to ensure a sensibly joined-up outcome with predictable financial consequences.

SUMMARY AND CONCLUSION

  38.  The franchising model, as it turns out, has a number of virtues in an environment where there is continued public subsidy of the network and therefore the need to influence the service level and quality to be procured. It is gradually being adopted across the EU, although certain member states are very resistant to a break-up of the state-owned monopoly service provider. Whether it represents best value for money of the options open to us is a matter of conjecture, requiring the considered formulation of a coherent alternative. It would seem unlikely to me that such a development, even if properly assessed, would be a priority for improving passenger rail services, especially given the huge costs associated with all re-structurings. But there are a number of improvements that need to be made, not least as described in the paper, to avoid losing the benefits of the joined-up planning processes that the SRA devised.

26 June 2006