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20 Sep 2018

Rail franchising: the balance between risk and reward

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If this were BBC Two's "Only Connect", we might expect Victoria Coren-Mitchell to be quizzing us on the connection between McNulty, Brown, Bowe and Shaw. You've guessed it: major reviews of the railway industry over the past 10 years. Into this illustrious group, we can now add Williams, with today's announcement of a wide-ranging review of the industry, which the government has described as "the most significant since privatisation".

The review, to be chaired by Keith Williams (deputy Chairman of the John Lewis Partnership) follows the recent, critical, report of the Transport Select Committee ("TSC") in relation to the failure of the East Coast franchise. The announcement has been made on the same day as publication of the – again critical – interim report of the Office of Rail and Road ("ORR") independent inquiry into the May timetable disruption.

Areas of the press – and politicians – are claiming that "franchising is broken". We disagree. The involvement of the private sector in operating the railway has been a huge success since it was first introduced: driving increased passenger numbers (and services), better quality rolling stock and, generally, higher customer satisfaction. By its nature, involving the private sector means we have to accept that, sometimes, franchises will fail. Admittedly, the May timetable disruption does not fall into this category but instead emphasises how vital it is for the industry to work closer together and to communicate better, earlier, presenting a united approach to the passenger (whilst not always falling back on strict contractual entitlements).

However, we are by no means trying to paint an overly-rosy picture: whilst franchising is not fundamentally flawed, it is far from perfect and a key element of the Williams review will be to consider where risks should properly lie. The TSC indicate that "the Government has not found the right balance between the risk of franchise failure and return they might obtain from encouraging ambitious bids". For a number of years now, the risks sought to be transferred to the private sector have continued to increase and the risk balance has tipped, whilst rewards remain relatively consistent (and have in some cases gone down). We hope the review will consider steps to redress the balance, whilst making sure that this balance remains fair between the taxpayer and the private sector, with risks being borne by the party better able to manage them.

In summary, the Williams review – which is deliberately broad – will consider the following areas:

  • Balance of risk:  how the franchise model can deliver improved services for passengers – and how it can most effectively balance the risks assumed by the public and private sectors.
  • Partnership: how the industry can work more closely together to reduce fragmentation, ensure accountability and improve passenger services, considering the roles of all parts of the industry and government.
  • Fares: how value for money for both the passenger and the taxpayer can be delivered (and, impliedly, the balance between taxpayer/passenger funding of the industry, which has shifted in recent years towards the latter).
  • Industrial relations: how industrial relations can be improved to maintain performance for passengers.

The terms of reference for the review – which is expected to take around a year – together with the Panel membership, will be published once Parliament returns following party conference season.

Transport Select Committee report on East Coast

A number of key points can be drawn from the TSC's report, which will no doubt influence the approach of the Williams review:

  • "Day one": East Coast revenue fell short of expectations from day one. This highlights the gap of two years or more between the information provided at bid stage and the franchise start date. Put simply, consideration needs to be given to how key bid predictions can be fairly updated between bid submission and "go live", whilst at all times respecting procurement rules. In connection with this, the TSC recommends that clarity is given on mechanisms available for franchise change and renegotiation – which could apply to day 1 but also, more generally, during the term of a franchise.
  • Passenger numbers: projected passenger growth on the East Coast never materialised. To what extent should franchisees be expected to take risk on changes in the economy or changing travel habits (for example, the reported decline in season ticket usage)? How could these factors be separated from franchisee-specific initiatives to drive revenue growth (for which the franchisee should properly be held to account)? At the same time, how do we ensure that appropriate resilience is built into bids (and that the levels of resilience are properly evaluated)?
  • Over-optimism: the TSC criticised the handling of the bid process and how unrealistic bids were not tempered (with stress testing not being sufficiently robust, so that weaknesses were not identified). With a significant element of bid success still being based on financials, measures are needed to ensure that realistic bids are submitted and carefully assessed, with risk adjustments being applied where appropriate.
  • Infrastructure assumptions: the TSC makes clear that Network Rail had no responsibility for failure of the East Coast franchise, delivering all infrastructure upgrades it had committed to (and had been funded to deliver). Unfortunately, assumptions were made in the bidding process about further upgrades for which there was no funding commitment and – as a result – will be delivered later than expected. Whilst this did not ultimately contribute to the franchise failing, this highlights the importance of ensuring that there is certainty at bid stage about what infrastructure will be available – and when. The Invitation to Tender needs to be more closely aligned with Network Rail's funded enhancement programme. Bidders need to ensure that promises made in their bids are deliverable and do not either commit to or rely upon infrastructure enhancements which may not materialise. Appropriate funding therefore needs to be included in bids – and assurances/an agreement obtained from Network Rail (where appropriate) that infrastructure work will actually be undertaken. Careful consideration will need to be given about who should properly take risk on infrastructure not being available as promised – as this could go to the heart of the service proposition and associated revenue. This will be particularly relevant in Control Period 6 where enhancements funding will be through a pipeline approach (where funded by government) or through market-led proposals (for enhancements promoted by third parties).

Ultimately, the TSC recommends that "any review of franchising should consider what change would be needed to the financial and regulatory framework to make partnership working a viable and sustainable model for operating the railway in the future." Partnership is therefore a continuing theme emerging from all areas of government.

ORR independent inquiry

The ORR has also published its interim findings from its inquiry into the May 2018 timetable disruption. By way of a reminder, this interim report focuses on evidence gathering and an analysis of the problems and their cause. Recommendations for change will follow as part of the next phase of the ORR's inquiry, with a final report expected before the end of the year. The interim report is highly critical and identifies factors contributing to the failure to develop/implement an effective timetable, as well as drawing conclusions about the management of operational risks created by major timetable changes.

In particular, the following key findings are likely to have an impact on the Williams review:

  • "Systemic weaknesses": there are weaknesses in the planning and delivery of major network changes and there is a risk of the May 2018 timetable disruption happening again if lessons are not learned. Governance processes failed to coordinate the industry to identify and manage the risks as they emerged.
  • Over-optimism: the industry was too optimistic about the viability of introducing the May 2018 timetable (or was too driven by franchise agreement obligations). Decisions to proceed with the timetable were made in January/February 2018, which was far too late, and meant passenger disruption was unavoidable. One reason for this was compressed driver training timescales – but the overall industry approach did not take into account the level of risk, offer reasonable challenge or allow for sufficient contingency.
  • Passenger information: this is an area of particular ORR criticism: passenger communication was poor. Passengers were not able to plan their journeys with any degree of certainty. Information provided to staff was inadequate and inaccurate. There was no certainty over whether trains would run, when "extra" trains would run (or where they would call) or why trains were being delayed.
  • System Operator: Network Rail's System Operator function was best placed to manage the risks but did not take sufficient action. It did not have the necessary processes or industry-wide arrangements in place to manage the system as a whole, which was a significant contributor to the disruption.

Ultimately, there is criticism of Network Rail (both in its delivery of major change and the System Operator function), the DfT and train operators as contributors to the disruption. However, there is also acknowledgment that there were many good examples where individuals were doing everything they could to mitigate the passenger impact – such as timetable writers and passenger-facing staff.

Interestingly, the ORR has also published a separate report on its role in the May 2018 timetable disruption. Whilst no single point of failure has been identified, the ORR's performance in setting the framework for Control Period 5 (2014 – 2019) and its ongoing monitoring of Network Rail's licence "could have been more effective" and so is considered to be contributory factor. In particular, the ORR did not identify the system-wide risks, despite having had awareness at an early stage of the risks, instead focussing its attention on Network Rail.

What next?

We have some sympathy with the position in which franchising now finds itself. The current franchise proposition reads as a history of past mistakes and lessons learned – hence the franchise agreement has increased in size over time. On the one hand, the government is encouraged to be "more commercial" in its approach to a dealing with its franchise partners and to offer flexibility in the franchise. On the other hand, it has been told it needs to be "more contractual" and rigorously enforce the terms of the franchise.

It is difficult to reconcile the two, save that it emphasises the importance of getting the franchise proposition right at the time it is tendered. This will involve a careful assessment of where risks should properly lie, recognising that by the time a franchise "goes live", information upon which bids were made could be two years out of date. It will also involve reviewing those past lessons learned and whether the resulting pages of contractual drafting are truly justified. Consideration should also be given to evolving the franchise agreement during its term, recognising that something sensible and commercial at the time of franchise award may no longer be wholly appropriate 5-10 years down the line.

We hope that the deputy chairman of the John Lewis Partnership can recommend helpful ways in which the rail industry as a whole can itself adopt a partnership way of working. What is clear is that this review will drive what franchising will look like for a long time to come. We would therefore strongly encourage industry parties to participate in the review – please get in touch with any member of the Stephenson Harwood Rail team if you would like assistance in doing so.

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KEY CONTACT

Tammy Samuel

Tammy Samuel
Partner

T:  +44 20 7809 2227 M:  +44 7766 991 053 Email Tammy | Vcard Office:  London

Suzanne Tarplee

Suzanne Tarplee
Partner

T:  + 44 20 7809 2389 M:  +44 7718 247 220 Email Suzanne | Vcard Office:  London

Darren Fodey

Darren Fodey
Senior associate

T:  +44 20 7809 2388 M:  +44 7920 201 290 Email Darren | Vcard Office:  London

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