Sunday, May 27, 2007

A practical example?

How could the principles in this post be put into effect? Here's an opportunity. Legendary trade reporter Roger Ford discusses the situation at GNER, where the company's franchise to operate the East Coast Main Line has been withdrawn because the parent company, Sea Containers, is in financial difficulty.

The details of the difficulty can be sketched briefly - unlike all the other rail franchises, GNER is profitable and rather than receiving a subsidy from the state, it actually pays the Department of Transport for the right to operate the service. There's the rub - when the contract with the DfT was last renewed, these payments were considerably increased, Sea Containers believing that it would be possible to operate more trains. However, under open-access requirements, they later had to hand over the train paths required to other operators. Without the extra net income, the payments to the Treasury couldn't be met, causing a cash crisis at the parent company.

The interesting thing is, though, that the DfT rather likes GNER. Wouldn't you? Even if it didn't make as much money as planned, it was after all one part of the rail network that wasn't either haemorraghing cash or becoming a national synonym for incompetence. They want to keep the existing management in place until the franchise is re-awarded, and perhaps even under new owners.

Which begs the question - what on earth would the new franchisees be for? Using GNER occasionally, and at times quite a lot since 1999, I strongly agree with the DfT Railways Directorate that they ought to keep the job. And, even in the event that the franchise changes hands, most of the staff will change hands with it, as will assets like the traction depot in Hornsey Green.

So - if all that a franchise change implies is a swap of top executives, it's arguable that the most likely change in the business this will produce is negative. Why not, then, just give the franchise to the people who work there? It could be structured in several ways, the simplest being the creation of a company owned by the 5,000 staff to take over the management of GNER.

Arguably, if GNER's position as the operator of the ECML doesn't give it any special claim to control access on the route, the very notion of a franchise from the government is absurd. They are just a large buyer of train paths and electricity from Network Rail's London North Eastern Region. What is the state, as opposed from the quasistate entity Network Rail, providing here? Nothing, is the short answer. Therefore it has no claim to any money, except for corporation tax and VAT. This is, of course, unlikely to go over well with DfT Rail or the Treasury. Note, by the way, that I'm highly sceptical of open access on the railway - it works for telecoms/internetworking because there is very loose coupling between services and networks, and the privatisation experience has told us that railways are a lot different. (Look at the pain and difficulty the SNCF and Deutsche Bahn had agreeing terms for their high speed trains to run through on each other's metals.)

If the government must have a piece of the action, I suggest this: it should lend the putative GNER Co-op the cash required to buy out Sea Containers, to be repaid over the life of the franchise at a reasonable interest rate. The risk would be minimal, backed as the loan would be by a stable cash flow and the right to re-award the job if GNER(C) went bust. Obviously, GNER(C) could choose to finance itself privately if it could get better terms, but this version is nice because it satisfies the objection that the Treasury wants its pie. (If it insisted, there could be a state profits participation defined as a percentage above some value, rather than a cash sum.)

At the moment, the new agreement provides that DfT Rail gets to grab all GNER's revenue, and then pay back "incentive payments" if it achieves various targets. I think mine is rather more elegant. The current position also foresees the business's net worth somehow migrating to the Government - mine would see the Government carrying an equivalent sum as an asset, and Sea Containers getting cash on the nail to go away.

To begin with, the scheme could have a fixed term of five years, with the option to continue or re-award - thus it would fulfil my criteria about test-driven development. It would be limited to one rail network, but could be generalised to others if it worked. It would get around the problem of "lemon socialism" - this is a real, successful operation.


Tom said...

I thought my occasional rail-related rants on Blairwatch were shouting in the wilderness, so it's refreshing there's someone else out there who reads and enjoys Mr. Ford's output and recognises the importance of the old maxim that you can judge a government by the way it treats its railways. The same may apply to ideologies, it seems. Also, Roger's line in military hardware/aeronautical metaphors are a constant delight.

Anyway, GNER. There is a key distinction you might have missed in what the Government supply franhisees as opposed to OA operators, in the form of the way revenue is shared. Under something called 'cap and collar', the DfT and franchise holder share revenue risk - if it falls short, the taxpayer forks out. If it's on target the franchisee forks out. If it's higher, the franchisee keeps the excess. GNER's problems were a whole heap worse, starting with 7/7 and going on through Sea Container's financial woes, which lead to GNER being unable to meet a contracted bond payment.

Open access operators (which are, incidentally, far less important than GNER tried to make out and aren't responsible for nicking any paths - the one in question hasn't started operating yet) aren't subject to the revenue sharing stuff and are thus solely responsible for when things go wrong. Given that, they have an incentive *not* to compete completely head on with a much bigger franchise holder who doesn't suffer equally, and indeed that's what's happened on the East Coast - Hull Trains picked up the traffic from Hull that GNER ignored and Grand Central, if they ever reach climbing speed, will do the same for Sunderland.

On premia, note that both First Great Western, South West Trains and Virgin West Coast have signed up to similar heroic/suicidal premium payment profiles to GNER. It's all in Uncle Roger's archive, although the full articles with substantial graphage are best read on paper. I have a complete archive half an hour or so by shiny German EMU from TYR headquarters if you're not a regular offline reader.

By the way, the rump GNER has now shacked up with Virgin/Stagecoach's bid for the East Coast, which I strongly suspect will win (the other option is First, which will be embarrassing if anyone compares Virgin WC with First's Great Western operation around franchise award time, particular wrt punctuality and customer satisfaction).

For extra brownie points, how many open access operators are there?

Alex said...

Glad to have you on board, Tom. I read Roger Ford's stuff religiously online. As a trade hack myself, I try to model my work on his example.

Message received and understood. But what do you think to my substantive proposal?

Roy Seaman said...

The Franchising of British Rail has followed the wrong route! There are only two ways to success. Franchising the Tracks to no more than four regional operators for a 25 year period, then Franchising the Stations to Regional Business Franchise owners. In this instance all existing stations would take on new leases of life and become hubs for commuters and businesses alike. They can also take on the Postal Franchises in certain cases.
Unfortunatly, there is little consistancy in government thinking, hence all the short fixes.
Roy Seaman Professor of Franchising. Franchise Development Services, Norwich. NR1 3FD

Tom said...

There's something I can't put my finger on that means it's probably not a flier, but that may be me being stuck in the DfT mindset rather too hard.

First, let's check I've got this right. In order to keep GNER ticking over, you lend them taxpayer's money to buy out Sea Containers' interest, thus keeping them running under the same team. This money is paid back over ten years instead of the billion quid premium that SC signed up to in 2005.

What exactly are you paying SC for? The assets of a franchise aren't exactly hugely valuable - the name, the intellectual property for logos etc. There aren't any trains or stations, the franchise itself isn't currently operating as a franchise, but as a management contract, while things like train leases are liabilities as much as assets (expensive refurbishments under way). How much would that lot cost? How much interest would be payable over ten years? Not a billion quid, I reckon, or anywhere close. Given the involvement of GNER management in the Virgin bid, there's a strong likelihood that the same guys will inherit the job, paint the trains red, and carry on as before. The possible spanner in the works is a Competition Commissioner noticing that all day trains from London to Scotland are run by Virgin/Stagecoach, but if we were really interested in on-rail competition we wouldn't have the current system, would we?

Given that, the Treasury has a marked disincentive to join in, and that they think they can extract a lot of cash out of the ICEC franchise it's going to be hard to persuade them fork out a couple of hundred million to give to a co-op in return for a lowish interest rate in return. There's already going to be a hoo-hah when the Government pulls the rug out from under NR's spending over the summer - railway finances are heading for a bit of a crunch.

Now, the other franchise holders awarded under the recent billion quid deals (SWT, FGW, VWC) wouldn't be too happy either. First, who are the biggest operator, would be extremely unhappy, since FGW still has to pay a billion-pound premium in full, and they compete with GNER in the south (FCC), middle (Hull Trains, Trans-Pennine) and north (Scotrail, sorta) and would thus have their business plans upset by what sounds very like a government-backed franchise bid. The probability of First reaching for their lawyers approaches one in that scenario, no doubt asking to be let off the premium payments for FCC and FGW, please.

The issue with any restructuring of franchising is there's never a good time - franchise bidding/awarding is more-or-less continuous, so the process of consultation, legislation and bringing in of new rules, which would be a three or four year game, would effectively freeze up the railway again only fifteen or so years after the last one. A more subtle approach is needed. I suggest, having got rid of the number one stupidest idea of privatisation, Railtrack, we should take aim at number two, which was that any organisation in the world was allowed to compete for UK passenger rail franchises, except the one with the most experience at running UK passenger rail services, BR.

I vote for setting up a Network Rail Train Operating Company, and allowing them to compete for franchises, and to take over any failing ones.

Oddly enough, GNER isn't a failed franchise, in the sense of being badly run (it's not Connex, ffs), it's mainly the premium profile and SC's insolvency that forced them to abandon the franchise commitments. The best idea under the current system may well be to transfer the skills to a more solvent operator and carry on like that, but it will be very interesting to watch how the bidders approach the premium profile.

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