Franchising Futures


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Experiences with franchising of, and open access for, passenger rail services in Great Britain John Preston Urbanet Conference, Oslo 8 September 2016

Outline Update papers in Research in Transportation Economics in 2008 and 2016 (pending). • A Brief History of Franchising (and Open Competition) • Key Trends.

• Key Issues: Competition, Objectives, Overoptimistic bids. • Franchising Futures. • Conclusions.

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A Very Brief History of Rail Franchising in Britain • First phase. 1996/7 – c2000. Associated with OPRAF. 25 TOCs franchised. Moderation of Competition Phase I. • Second phase. c2001-2004. Associated with SRA. 9 TOCs (re)-franchised. Moderation of Competition Phase II. Hull Trains. • Third phase. 2005-12. Associated with DfT. 13 TOCs (re)franchised. Moderation of Competition Phase III. Grand Central. • Fourth phase. 2012-13. ‘Failure’ of West Coast Franchise and instigation of the Laidlaw Enquiry and Brown Review.

• Fifth phase 2014-. 7 (re-) franchises so far.

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Regulatory Structures V

4

Open Access 2015/16

Passenger Train Kms (millions)

Franchised Market

57.3

Non Franchised Market

4.6 (0.9%)

Total

521.8

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The Evolution of Franchising

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Franchise Schedule

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Trends: Passenger Kms (Billion) 70,0 60,0 50,0 40,0 30,0

1995/6 – 00/1 +31% 2001/2 – 04/5 +7%

20,0

2005/6 – 11/12 +34%

10,0

2012/13 – 14/15 +10%

0,0

Total

Source: Syarifuddin, 2016, based on data from ORR National Rail Trends http://dataportal.orr.gov.uk/

+108%

Trends: Train Kms (Millions) 600

500

400

1995/6 – 00/1

+21%

2000/1 – 04/5

+7%

2005/6 – 11/12 +11% 2012/13 – 14/15 +1%

300

200

100

0

Total

+46%

Trends: Unit Costs (I) 40

Passenger Service Costs per TKm

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1995/6 – 00/1 +20% 2001/2 – 04/5 +18%

25

2005/6 – 11/12

20

2012/13 – 14/15 +5%

Total

15

+2%

+52%

10 5 0

1979/80 1980/81 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88 1988/89 1989/90 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15

£/TKm

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TOC Operating Costs per TKm (£/TKm)

Rolling Stock Costs per TKm (£/TKm)

Total Passenger Service Costs per TKm (£/TKm)

Total Industry Costs per TKm (£/TKm)

Source: Syarifuddin, 2016. Main growth in Renewals Costs 10

CF Renewal Costs per TKm

Source: Syarifuddin, 2016. Note importance of the counterfactual. 2014/15

2013/14

2012/13

2011/12

2010/11

2009/10

2008/09

2007/08

2006/07

2005/06

2004/05

2003/04

2002/03

2001/02

2000/01

1999/00

1998/99

1997/98

1996/97

1995/96

1994/95

1993/94

1992/93

1991/92

1990/91

1989/90

1988/89

1987/88

1986/87

1985/86

1984/85

1983/84

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1982/83

1981/82

1980/81

1979/80

£/TKm

Trends: Unit Costs (II) Actual & Counterfactual Infrastructure Renewal Costs per TKm

12

10

8

6

4

2

0

Renewal Costs per TKm (£/TKm)

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1979-80 1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15

Trends: Government Support (£ Million 2014 prices)

8000

1994/5 – 00/1 -38%

7000

2001/2 – 04/5 +185%

6000

2005/6 –11/12 0%

5000

2012/13 – 13/14 +1%

4000

Total +79%

3000

2000

1000

0

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Estimated Welfare Effects (£ B) Overall

Increase in Net Effect Infrastructure Costs

1995/6 – 2000/1

+2.2

+1.4

+3.6

2001/2 – 2004/5

-11.7

+12.1

+0.4

2005/6 – 2011/12

-8.0

+13.0

+5.0

2012/13 2014/15

-1.9

+6.4

+4.5

Total

-19.4

+32.9

+13.5

Based on Syarifuddin (2016). Update of Robins (2012). If each franchise had bidding costs of £22.5M then the net benefits of £13.5B are offset 13 by transaction costs of £1.2B.

Issue (I) Level of Competition and the Winning Bid Franchising has been competitive, but competition declining over time: • First phase:

5.4 bids per franchise

• Second phase:

4.2 bids per franchise

• Third phase:

3.8 bids per franchise.

• Fourth and fifth phases Down to 2 bids per franchise, although current pool of 10 active bidders. High bidding costs (£5M per bidder in 2006, £10M in 2012). Are rail franchises a common value auction – so as the number 14 of bids goes down prices go up?

Issue (I) Level of Competition and the Winning Bid

Only 3 out of 55 franchises have failed. However, 13 franchises renegotiated after Hatfield 2000 and 12 direct awards after 2013. Serial failure to meet financial targets. Winner’s curse or strategic game playing? 15

Issue (II) Objectives What is franchising trying to achieve? (i) To harness private sector commercial judgement and innovation to reduce the net cost and increase the value for money achieved from the Government’s overall support for passenger rail services. (ii) To improve passenger services, commensurate with funding available. (iii) To set the level of service needed and to vary specifications to reflect changing market needs and accommodate future passenger growth. (iv) To protect passengers from the power of unregulated monopolies. (v) To maximise the benefits of the network as a whole. (vi) To fit rail within Government’s wider public transport objectives.

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Issue (II) Objectives Brown Review: (i) Ensure value for money by competition for the market.

(ii) Harness private sector skills and innovation. (iii) Ensure stability of service. (iv) Secure franchisees who will work in partnership. (v) Facilitate further devolution of decision making. (vi) Ensure services are delivered and managed by organisations which are attuned to local market needs.

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Issue (II) Objectives

Issue (III) Overoptimistic Bids The East Coast Franchise Date Started

Expected Duration

PVNP 1st year (£m)

GNER

April 1996

7 years

65

GNER

May 2005

10 years

(50)

(219)

National Express

Dec. 2007

7 ¼ years

7

(311)

Virgin Trains

March 2015

8 years

(198)1

(372)2

Sources: Preston (2008 and 2016) and adapted from Ford (2015) 1Based on 2015/16 premium deflated by 1.035 2Based on 2022/3 premium deflated by 1.0358 Figures in brackets denote premia paid.

PVNP Final year (£m)

0

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Issue (III) Overoptimistic Bids Cap and collar regime intended to promote efficient bidding given concern that post Hatfield bidders would be overly risk averse. Some concern that it mutes incentives to grow revenue. Front loaded subsidy may be used to finance Parent Group activity. Seems to have led to strategic behaviour, although extreme gaming behaviour should be detected at the bid evaluation stage.

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Issue (III) Overoptimistic Bids West Coast franchise replaced the cap and collar regime but with bidders required to have in place a subordinated loan facility (SLF) to be drawn upon in case of default. 21/01/12 ITT issued 15/08/12 Intention to award to First Group 03/10/12 Cancellation of franchise and suspension of programme.

Laidlaw Enquiry highlighted (i) lack of transparency with SLF process (ii) technical mistakes in the calculation of the SLF (iii) contributory factors relating to lack of planning resource. 21

Alternative Contract Specifications • ‘Commercial’ franchises (long distance services): longer length, looser specification, remain net subsidy.

• ‘Social’ franchises (short distance commuter and regional services): shorter length, tighter specification, gross cost. • Experimentation with vertical re-integration and microfranchises. • Brown favours 7 to 10 years franchises, with a 3 to 5 years continuation mechanism. Management contracts where major upheavals. Concessions where authority has marketing capabilities. Against cross default provisions. • Some calls for re-nationalisation via DOR. 22

Franchising Futures – Key components Risk allocation

Capital requirements

Revenue risk

Parent Company Support (Guarantee)

Cost risk Profit risk Regulatory risk Inflation risk Open access risk

Profit

Profit above a given level shared with DfT

Performance bond

Season ticket bond

Profit cap

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Franchising Futures: Parent Company Support (PCS) The PCS requirement will be proportional to bid “ambition” above a certain level.

In this example, a bidder would be required to provide a minimum PCS of £30m, with bids above £1.3bn requiring additional PCS at a rate of £100k for every additional £1m bid.

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Franchising Futures: Risk Allocation For some franchises, the DfT may offer to share some or all financial risk with a franchisee. The design of the risk sharing arrangement will depend on the characteristics of the particular franchise and will affect TOC financial stability and incentives. Management contract e.g. West Coast “Cap & collar” (a special case of revenue share & support) e.g. Southern

Increasing risk with the TOC

Cost risk with the TOC, revenue risk with DfT e.g. Thameslink

Revenue share & support e.g. Greater Anglia

All risk with the TOC e.g. Essex Thameside GDP based mechanism e.g. East Coast

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Revenue

Risk allocation – an illustration Revenue share line

Target Revenue Revenue support line

No revenue support for shortfall

TOC not yet eligible for Revenue Support

revenue support for shortfall

Actual revenue

TOC eligible for Revenue support

Time

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Conclusions (I) Contracting-out has proved more problematic for rail than for bus, particularly for long-distance commercial operations. Five Phases of National Rail Franchising in Britain Phase

Dates

Responsible Authority

Achievements

Assessment

1

1996 – 2000

OPRAF

25 franchises let

Initial success

2

2001 – 2004

SRA

Cost over-runs post Hatfield.

3

2005 – 20012

DfT – Cap and Collar

9 franchises relet, 1 failure, 13 renegotiated. 12 franchises relet. 2 failures

4

2012 – 2013

DfT – SLF

1 cancellation

5

2014 –

DfT – Horses for courses

7 franchises relet by summer 2016. 8 more by 2022.

Short comings in evaluation 12 Direct awards.

Revenue shortfalls.

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Conclusions (II) The DfT’s ‘horses for courses’ approach intends to address this but other important considerations. 1. Subsidy is going to be re-directed from infrastructure (Network Rail) to the operators (TOCs). 2. Network Rail to undergo internal reform as a result of the Shaw Report 3. The CMA is investigating ways of boosting on-track and/or off-track competition. Move to a two-speed franchising process with gross cost contracts for social services but more loosely specified and more highly incentivised contracts for longer distance commercial services.

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