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British franchising policy rewards high bids

01 Feb 2007

LAST NOVEMBER the UK House of Commons Transport Committee published a hard-hitting report about the franchising process for passenger services (RG 12.06 p768), describing the current structure as a 'complex, fragmented and costly muddle'.

In terms of cost, the Association of Train Operating Companies estimates that it costs between £3m and £5m to make a franchise bid. The Department for Transport puts its costs for letting a franchise at £2·5m, giving a total cost for a franchise with four bidders between £14·5m and £22·5m.

Be that as it may, the franchise map is slowly being redrawn with regional and long-distance service groups combined into franchises forming geographical entities. This is the case with the Greater Western franchise, which merges the former Great Western inter-city services with what were previously Wessex Trains' regional services in the west of England and the commuter services into London Paddington.

Major changes are being made to the CrossCountry franchise, which relinquishes Birmingham - Scotland services to Virgin West Coast and gains some routes from the Central Trains franchise, which is being broken up. Other parts of Central will be divided between new East Midlands and West Midlands franchises that will commence in November this year. East Midlands includes the Midland Main Line inter-city services between London St Pancras and Derby, Nottingham and Sheffield, and West Midlands embraces the Silverlink County outer-suburban services between London and Northampton.

Yet another significant alteration to the franchise pattern sees Transport for London assume control of Silverlink Metro inner-suburban services from November (p89). MTR Laing and Govia have reached the final stage of bidding for the concession to run what will be known as London Overground, and the winner is to be announced this summer. When the remapping is completed, the number of franchises will have been cut from 25 to 20.

Premium payments

Perhaps the most remarkable element to emerge from recent franchising policy is that operators are signing up to deals that commit them to pay massive premia to the government. These premia are over and above the profit made by the franchisee, and questions about the wisdom of this policy began to mount towards the end of last year as it became obvious that GNER was encountering severe financial problems with its InterCity East Coast franchise.

When it signed up in March 2005, the Sea Containers subsidiary had beaten its rivals by promising to pay premia on the basis of growth forecasts which assumed that revenues would increase at 8·6% a year throughout the 10 years of the new franchise. By August last year it was clear that GNER was missing its targets, and discussions began with the Department for Transport, leading to the decision announced on December 15 to relet the franchise.

Expressions of interest for ICEC were due on January 15 FirstGroup, Virgin and National Express were among those responding. A shortlist is being announced on February 9, and invitations to tender will be issued in March with bids to be submitted in June. The winner is due to be announced in July or August.

Had GNER stayed the course, its premium payments would have amounted to a staggering total of £1·9bn over the life of the franchise. Yet according to Transport Minister Tom Harris, it would seem that the premium payments were not the problem. Speaking in the House of Commons on December 19, Harris said the franchise had to be terminated because of problems at parent company Sea Containers, which on October 15 last year filed for protection from bankruptcy under the Chapter 11 procedure familiar to those who follow the fortunes and misfortunes of the US airline industry.

GNER was not alone in signing up to a high premium profile. Later in 2005 FirstGroup signed agreements for the Greater Western and Thameslink/Great Northern franchises which began on April 1 2006 - in both cases a similarly demanding profile of premia is required (Fig I).

The Greater Western franchise starts with subsidy payments which reduce rapidly in 2008-09, switching to a premium in 2009-10. From then on the premia rise steeply to culminate at £428m in 2015-16, giving a total for the franchise period of nearly £1·5bn.

FirstGroup rebranded the Thameslink/Great Northern franchise as First Capital Connect, and this started with a premium payment of £14m in the 2006-07 financial year, rising to £205m in 2014-15. While this is less ambitious than Greater Western, it is still based on an assumption of continuous growth. Some protection against an economic downturn has been built into the franchise agreements, but they still call for exceptional financial performance.

Yet another high-premium franchise was confirmed last September when incumbent operator Stagecoach retained the South West Trains franchise for 10 years, albeit combining the former Island Line into a new franchise known as South Western. This starts on February 4 and runs until 2016-17, during which time Stagecoach is contracted to make premium payments totalling almost £1·6bn.

Taken together, the four franchises would generate nearly £6bn over the next decade - although in practice the figure may be somewhat lower as GNER's successor may not sign up to the same level of payments. On the other hand Transport Minister Tom Harris said on December 19 that the premia GNER had agreed were 'easily achievable'.

The four deals offer a remarkable contrast with Virgin Rail Group's InterCity West Coast franchise. Sir Richard Branson's rail business originally signed up to high premium payments which hinged on successful upgrading of the West Coast Main Line. All this fell apart when Railtrack failed to deliver the upgrade, but under Network Rail the West Coast Route Modernisation is now largely complete - paving the way for the restoration of the franchise in December.

In marked contrast to the ICEC and Greater Western franchises, the revised agreement sees DfT paying Virgin £1·2bn in subsidy over the five years to 2012. This is explained by a much higher level of fixed access charges for use of the West Coast Main Line, where more than £8bn has been spent on the upgrade.

An intriguing question is what happens to the premia. Notionally, the money is used to offset the direct grants paid to Network Rail by the government, effectively refunding the subsidy paid into the industry. Whether this will continue in future will only become clear once HLOS and SoFA have been published.

  • CAPTION: UK passenger operations are steadily being consolidated to reduce the overall number of franchises. FirstGroup's Greater Western franchise, which runs trains into London Paddington, comprises Great Western inter-city services as well as the former Thames Trains and Wessex Trains businesses
    Photos: Brian Morrison
  • CAPTION: InterCity East Coast operator GNER is now running services under a management contract pending the reletting of the franchise. GNER's recent financial troubles meant that it would be unable to meet its commitments
  • CAPTION: Virgin West Coast has emerged from its management contract with a restructured franchise that will see it receive £1·2bn in subsidy from government to cover higher track access charges. After major disruption caused by route upgrading work, West Coast inter-city traffic has increased sharply over the past two years
  • CAPTION: Fig I. All four recently-retendered franchises call for a steep rise in premia to be paid to government over the life of the franchise. GNER has already admitted defeat in its efforts to meet these obligations