Opening comments of the report by Credo Business Consulting
The franchise model developed for the UK passenger rail network was created at a time of stagnant revenue and falling passenger demand. It was intended to reduce the burden of the network on government finances However, events of the past twenty years show that the rail network has followed a rather different trajectory, with improved external conditions and revived commercial management stimulating unprecedented growth.
As a result, the franchises themselves have changed considerably. What was originally 25 franchises all let centrally has become only 20 franchises – 15 let by the DfT. The average turnover of these 15 businesses has more than tripled, from £192m in 1998 to £744m in 2016. Over the same period, the ownership of the operating franchises has changed, whilst the risks of winning and losing a limited number of very large contracts has had profound impacts on the industry supply chain.
This growth could be seen as a strong endorsement of a system which has proven to be flexible, adaptable and transformed the finances of the railway. The continued re-letting of franchises, the strong interest international operators have in the UK and the success UK operators have had overseas support this.
However, the challenges of improving operating performance and meeting the capacity requirements placed on the network mean that many passengers may not agree. Moreover, the franchising model may be facing a period of significant risk and uncertainty which could ultimately make it unsustainable:
• Recent bids have been predicated on strong revenue growth. Such ambitious targets may prove challenging for operators – especially in the context of a slowdown in the rate of growth in rail demand over the last 18 months. if that does turn out to be the case the economics of the franchises means that the financial implications could be significant.
• Meanwhile the concentration of the industry in a small number of very large franchises creates risks for the supply chain. Whether an operator wins or loses any given franchise can have a disproportionate impact of the size of its overall business, making it difficult to ensure a sustainable investment strategy and plan accordingly.
Additionally, it is not clear that the current franchising model is best placed to support the wider development of the rail industry or reflect its role as a key catalyst of the UK’s economy. Specifically:
• The current franchise model has struggled to create the right mechanism to support investment or encourage decision which are made on the basis of whole life costs. Whilst attempts to address this have been made – including through longer franchises – these have tended to import too much risk into the franchises themselves and risk creating an unsustainable model
• The current franchise model has also struggled to deliver optimal solutions for the development of key assets such as stations or support an industry wide strategy for rolling stock which minimises long term cost and supports innovation. A lack of integration with Network Rail – both in terms of incentives and planning horizons – has also created problems