Rail

The state of national rail franchising in the UK

Posted on October 23, 2018

Kings Cross Station, London
All photos courtesy Giles Bailey
Kings Cross Station, London
All photos courtesy Giles Bailey
The UK’s Department for Transport has announced yet another review of the state of the country’s national rail franchising system. The Minister said in September that he wanted a review that “will consider all parts of the rail industry, from the current franchising system and industry structures to accountability and value for money for passengers and taxpayers.” The review is expected to announce some outcomes in late 2019 and is the latest in a long series of reviews, analyses, restructures, and redesigns of the rail system in the UK over the last 25 years since privatization of the previously government-operated network began. Over the longer term, government control of the operation of railways was implemented shortly after the Second World War under British Rail.

Any discussion of railways in the UK should be considered in the context of the universality of access and importance of rail travel in the country. The vast majority of the population of the UK lives within a few miles of a railway station. While in many rural and outer suburban areas the rails may act as a trunk service for occasional or long-distance travel, in the larger cities, and particularly in London, they are critical to mobility and access to employment, services, and entertainment. For these cities, there is simply no capacity on the road network as an alternative to rail travel.

Over 1.7 billion journeys were made on the circa 10,000 miles of railways in the UK in 2016. Demand has almost doubled since the late 1990s. The era of the privatized national network has seen a surge in demand for railways. This can be attributed to a range of factors, including a slower rate of fare increases since the early 1990s, growing urban employment particularly in central London, increasing congestion on the national road network that has been developing slowly, more services and new rail routes, and simply the popularity of rail as a convenient and sustainable way of travel.

However, this has been a rather bumpy road for the industry, and particularly the government. The overall level of public satisfaction with the railways is distinctly falling at present while public subsidies for service have not decreased since privatization and infrastructure investment has increased in response to demand and broader public environmental policy goals. Politically, the opposition party in parliament sees renationalization as the way forward.

As stated, in most European countries rail travel is critical to a well-functioning multimodal transport system. This is particularly for commuters to larger cities as well as business travel. This dynamic includes countries like the Netherlands, Italy, France, Germany, and the UK.

Personally, I would not consider intercity driving to a business meeting — or for that matter, attending a meeting in a location not served by some reasonable rail service.

Waterloo Station, London
 
Waterloo Station, London
 
In a wider European context, the EU’s Fourth Railway Package has set in process the introduction of competition in international (cross border) rail services and intercity services within countries. Furthermore, many countries are using some form of tendering for local rail services, even if the former state operator retains the tender. In several countries, a market for rail services has already developed with open access operators challenging incumbents.

The Move to Privatization

The UK began privatization 25 years ago, and in 1995, the first franchised Train Operating Companies (TOCs) were Southwest Trains and Great Western. Over a number of years, all operations were moved to private franchises and the railway infrastructure of trains and tracks were moved to the private sector. A long series of other organizations were also created or enhanced to manage issues such as inter-operator ticketing and information, staff responsibilities, property, rolling stock, safety and oversight, and various peripheral business assets.

The franchise model is based on the government defining a set of services that it wishes to procure over a number of years — say 10 years. The franchise is typically well-defined in terms of frequencies, regulated fares — most fares are regulated, but operators also have fares that they can set themselves within the market — and other matters. Companies bid to operate the franchise and indicate based on existing operation of those services whether they expect to require government subsidies or pay the government money based on making profits. In either case, the operator makes a margin on the operation of the services after paying for trains, power, staff, station operations, ticketing, etc. There are roughly 20 franchises, but these have varied over the years as the government has taken differing views of how most effectively to manage a myriad of train services across the country. Typically, most franchises focus on a major city conurbation or London mainline train station such as Waterloo.

A number of the particularly long-distance franchises are very profitable, such as the East Coast mainline, West Coast mainline, or Southwest services. Thus, franchisees compete for who can grow demand the most, control costs, develop new markets and infrastructure with Network Rail, and thus, maximize demand.

Trains are typically held by a few large leasing organizations that re-lease them to operators of successful franchise bids. This dealt with the issue of winning franchise bidders being able to access existing, as well as new rolling stock quickly to be able to operate services.

Kings Cross Station, London
Kings Cross Station, London

The railway infrastructure including tracks, stations, and signals was originally privatized to a private organization called Railtrack. This caused a number of longer-term issues as a private operator controlled via shareholders was in practice dependent on public funding either through government grants or franchise fees from train operators, who were in turn often dependent on government grants. The more Railtrack tried to act like a private business, the more friction was created with government and public policy needs. This eventually led to a crisis due to railway maintenance and a series of train crashes in late 1990s, which shattered public and government confidence in Railtrack’s abilities. It was allowed by the government to become bankrupt as public support was withheld, and eventually, the railway infrastructure was taken back by the government and passed to a new organization — Network Rail that was fully controlled by the government, but at arm’s length, in 2002.

Government Participation

The government has significantly increased investment in rail infrastructure to support the economy, meet demand, and support development across the country. The UK’s rail network is still heavily congested and limited in its capacity to absorb new services.

Thus, even though in theory new operators can ask the regulator to operate services in addition to the public franchises and compete in the private market this has only occurred in limited cases. These open access operators, for example, operate from London Kings Cross to East Yorkshire and West Yorkshire. There simply isn’t the capacity — as there is in the air market — to actually have a vigorous open market in services with new entrants coming into and leaving the market as competitive pressures and market innovation dictate.

Furthermore, the commuter market is actually too dependent on reliable train services to be able to withstand the market chaos of vigorous competition. People simply demand regular train service to get to work on a daily basis.

From the early days of privatization, and continuing today, we see a range of the franchises financially suffer, fail, or be beset by customer complaints at the level of service.

It should be remembered, though, that numbers using the rail network have increased significantly over the years. Customer expectations in all modes of transport have also increased. The old British Rail, while looked back at romantically, was not held in universally high regard at the time due to dirty, old trains and poor operational and customer service. This was a symptom of being directly part of the government’s wide range of publically operated services.

Clapham Junction Station
Clapham Junction Station

British Rail was deemed expensive to operate and privatization was supposed to cut these costs and bring a focus on improving service. This hasn’t quite happened, particularly regarding total funding. The funding has been rearranged and passed to different actors and involves a range of private businesses. However, the UK government still spends over $12 billion annually on the rail system, including the subsidies to Network Rail.

Moreover, the envisaged market in rail services has not emerged in a significant way in the UK. Services are dominated by the government-mandated franchises, and over the years, the Department for Transport has become more directive in specifying the details of services as a result of infrastructure upgrades, managing the complex and overlapping needs of the network, and at times the perceived lack of customer focus of the operators. Competition “on the rail” has not occurred as opposed to competition between railways and other modes of transport.

Looking at other European countries substantial competition in intercity rail services has up to now really only emerged in Italy — between Trenitalia and NTV, Austria — OBB and Westbahn, the Czech Republic — CD, LeoExpress and RegioJet, and perhaps Sweden with SJ and MTR. Competition is also slowly emerging as former state operators extend services into neighboring countries — for example DeutscheBahn and Thalys (SNCF) services into Brussels, Belgium.

While the former state operators see the competitive threat of new entrants into national rail markets as well as other means of intercity transport such as low-cost airlines, coaches, and ride-sharing, this is being vigorously challenged with new and refocused services.

Twenty-five years ago a range of new businesses bid to operate rail services including bus and coach operators — National Express, First Group, Stagecoach, and more, as well as maritime shipping companies such as Sea Containers and property developers such as James Laing. Over the years, the need for deep financial resources as well as experience in running train services has led to the UK market being dominated by the former state-run European operators such as SNCF (via Keolis in a partnership with Go-Ahead — a UK bus company — in a business venture known as Govia); DeutscheBahn’s Arriva Trains unit; Nederlands Spoorwegen’s (NS) Abellio; and recently, Trenitalia has entered the UK market purchasing a franchise from the UK’s National Express — a coach operator. MTR — the Hong Kong rapid transport operator — has also entered the UK rail market in partnership with local partners and is developing an open access operator presence in Sweden.

Over the years, a number of franchises have been over-ambitious in making promises in their franchise bids and slower revenue growth or infrastructure upgrade delays have pushed these franchises toward financial collapse. It should be noted that financial bonds held by the government to operate franchises are often worth many tens of millions of pounds and failure to meet obligations can lead to a forfeiture of these bonds. In addition, payments to government for the profitable franchises can be worth hundreds of millions of pounds per year and the operators have a limited ability to increase services on an already very busy network — or politically to reduce services, and thus, costs while many of the costs regarding track access, stations, staff, and rolling stock are all approximately fixed. Getting the numbers wrong in a franchise bid can be extremely financially punishing and this is one of the reasons only very large existing train operators are choosing to enter the bidding process.

London Bridge Station
London Bridge Station

Thus, in 2018 the East Coast mainline has for the third time since privatization had an operator financially fail and the business revert to the government to run. Several franchises are also operating outside of the bid process, whereby the operator runs the service on a “direct award” contract with the Department for Transport as for many reasons it has not been possible to run a competitive bidding process. This category includes Cross Country Trains, Great Western, and Virgin Trains West Coast.

Even more problematically for the government and industry, it is beset with customer concern and anger about ever increasing fares — government policy is to increase regulated fares each January a few percentage points above the inflation rate the previous July. This increases the traveler contribution to the funding of the system over time — subsidy per traveler has significantly decreased since privatization. As a result, fares can be very high. For example, a very popular annual ticket from Brighton on the south coast of England to London Victoria is currently approximately $56.

Impact of Privatization

Other concerns include an ongoing series of labor relations issues across the network about changing the working conditions of staff and the resulting inability of a number of franchises to run reliable services. This has particularly hit the busy Southern rail services operating south of London and has now been ongoing on and off for several years.

The industry is structured to bid as high as possible to run a franchise and then tries to extract as much revenue as possible from its operation within a very defined few years. This isn’t necessarily an incentive to consider the long term future of the railways, or its customers and assets, and has led to constant and perpetual complaints — albeit which vary across the network.

Public concern about the structure of the industry peaked in the spring of 2018 when a long-proposed and scheduled set of service changes around London on Southern, Thameslink and Great Northern routes, and Northern Rail services in Lancashire, Merseyside, Cheshire, and across Yorkshire, which affected almost all existing routes led to chaos throughout the summer. The planning for these changes was rushed and incomplete, and when implemented, sufficient drivers were not trained. The operators, Network Rail, and the government each blamed each other for not delivering on something that everyone otherwise seemed to agree was ready to be delivered up until the start date.

Reading Station
Reading Station

Network Rail, while managing a huge and disperse estate and ultimately delivering huge investment programs of tens of billions of pounds, has also faced public and government anger that many of its investment programs are months, if not years, late and hugely over budget. For example, the electrification of routes from London Paddington to the Bristol and South Wales is still ongoing and expected to be delivered three times over the original budget at near $6.4 billion and many years beyond its original forecast.

That said, the industry has delivered thousands of new carriages of modern rolling stock — particularly over the last decade and continues to thoroughly modernize the vehicular experience for travelers. Travelers can also be extremely proud of showcase stations, such as London St Pancras, London Bridge, Birmingham New Street, and Reading, which have been rebuilt and act as architectural showcases for further local and regional investment. The industry has also become much better at providing customers with relevant and up-to-date information regarding services and how they are running as well as managing service delays.

Nevertheless, renationalizing all or parts is gaining political traction. Transport for London (TfL) is still a public body in London and runs a much more highly regarded London Underground system fully within the public sector. TfL also runs the DLR and London Overground as franchises, but with tightly controlled specifications and TfL taking public responsibility for the overall service to customers.

North American Impact

What does this experience mean for North America? Railway services and infrastructure is largely in the private sector, although most commuter and intercity services are publically operated as they are unprofitable and socially-needed services. Many of the services are operated under contracts, but with tightly specified specifications where operators do not have the freedom that was envisaged under the UK franchising system.

The slow, but steady growth in new high-speed services in North America will generate a new renaissance for considering the role of intercity train services. It will also call into question the options for specifying the type of operating model, the role of the state in supporting or guiding these services, and whether competition can, or for that matter should, be a goal in the operation of these markets. The cost of market entry and barriers to effectively running a rail service are naturally high.

What type of market in passenger railways do North American policy makers, as well travelers, eventually want to see? Does choice matter between different rail operators, or is the real choice between an effective intercity rail service and other modal choices? Many Europeans take high quality intercity rail service as being a natural modal choice and generally demand is increasing for these services. Like most consumers they are demanding better services, and this is generally leading to a much more market-focused competitive solution in Europe. However, the UK’s experience over 25 years is that the government is still struggling to make a “market” operate effectively and efficiently on its railways and convince the public that this is right solution for the UK.

Giles K. Bailey is a director at Stratageeb Ltd., a London-based consultancy assisting businesses think about their strategic vision and innovation.

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