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INFORMED SOURCES December 2006

Franchise charivari

Jeremy loses interest, while bob still doesn't get it

On 1 November the Hong Kong Mass Transit Railway, MTR , announced that it had decided to pull out of the bidding for the re-mapped West Midlands franchise. This caused a small stir, not least, because when the shortlist for West Midlands was announced it was considered weak compared with the East Midlands and New Cross Country shortlists released at the same time.

Of the three replacement franchises, West Midlands alone had a trio of would be bidders where East Midlands and Cross Country had four. In addition, none of the three bidders had prequalified for either of the other two replacement franchises.

National Express, the effective incumbent through Central Trains and which had prequalified for the other two replacement franchises, had noticeably failed to make the cut. Nor had the other uber-bus bandit, First Group which was also in the other two shortlists.

Serco and NedRail, successful joint bidders for Northern and the 25 year MerseyRail franchise, had, reportedly, also parted brass rags as far as new bids went some months ago. Now, here they were, back together again. Govia completed the shortest shortlist.

Theory

My theory was that West Midlands is all about Centro. This made Serco/NedRail an attractive potential franchise operator with their experience of dealing with ambitious Passenger Transport Executives. Similarly, MTR knows a lot about busy urban and suburban networks on its home turf.

And when I saw MTR 's Chief Executive Officer for Europe Jeremy Long in London at the end of September he was clear what the organisation could bring to a UK franchise. He reminded me that MTR is essentially a European railway, originally built and equipped largely by UK companies. For example, the Metro-Cammell built trains are recording reliability figures of 99.95%.

This is the result of years of continuous improvement, one of MTR 's philosophes which would shape a UK franchise. Further improvement would come from what Jeremy termed ‘a dose of international best practice'. And while I usually roll my eyes at this business cliché, it is worth noting that he has seen the world from both sides now, first as Chief Executive of GB Railways and now in Hong Kong .

Practice

Thus, unlike some foreign would–be franchisees, who have turned out to be all mouth and trousers – Danish State Railways is the latest to fold its tents and silently steal away – MTR is not naïve and knows the form of DfT Rail's franchise procurement.

Particularly as it was an unsuccessful bidder for South Western, initially with GNER and, in a final dash, with National Express. And I suspect it was this that led to the decision to withdraw from West Midlands .

My initial view was that MTR had looked at the Stagecoach numbers and decided that it could not provide the quality of service people associate with the company for that type of money. In other words, it was a question of reputation risk.

But. according to Informed Sources, that was not the case. MTR is not a high cost operator and had identified cost efficiencies it could bring to the UK .

What drove the decision were our old friends risk and reward. Remember that it costs the thick end of £5 million to mount a serious franchise bid. Add to that the low margins needed to win a franchise today and the resources that would be needed to make West Midlands fly and the game was not worth the possible candle.

For MTR , didding with Lacing for the London Rail Concession is a different matter. Mayor Ken wants the former Silverlink Metro and the new East London Rail to be noticeably different. MTR believes the consortium has the capability to transform.

May withdrawal?

Meanwhile, Sea Containers' President & CEO Bob MacKenzie, quoted by the Sunday Times, has confirmed what many of us expected, namely that the company will withdraw from the GNER franchise if new terms cannot be renegotiated by the end of April. From 1 May, the performance bond, which is forfeited if GNER terminates the franchise, increases from £15.3 million to £28.7 million. Describing May 1 as 'the important date' MacKenzie repeated that he hoped an agreement with Government could be reached before then.

But every time DfT Rail chants it's mantra that it is not prepared to renegotiate franchise agreements, the potential reputational damage from a financial rapprochement with Sea Containers increases. In effect the British Government would be helping to bail out an overseas company.

What fascinates me is the way Bob clings to the belief that the franchise is profitable, but can't generate sufficient margins to cover the increasing premium payments. This misses the point that track access charges are, as Mr Justice Sullivan put it, ‘an artificial construct.

In most cases franchised train operators can pay premia only because they are not meeting their full track access charges. Under the terms of the 2003 Access Charge Review, over half of Network Rail's income is paid as direct grant.

In other words the collective premia are used to offset Network Rail's direct grant. And, as this little Table shows ff the direct grant is allocated pro-rata to the train operating companies, GNER's ‘premium' turns into subsidy.

Table 4

Impact of Network Rail's Direct Grant on GNER

Meanwhile, there is good reason for Sea Containers to stick it out until May. The company has filed a claim for force majeure to cover loss of revenue after the July 2005 London bombings. This loss represents just over half of the £33 million revenue shortfall revealed in Sea Containers' August 11 statement.

Payment of this sum would go direct to the bottom line, minimising the loss before the franchise is returned. In effect, it would offset the current value of the performance bond.

Equally, DfT Rail would find £17-18 million a handy sum to have in reserve were it to become the Inter-City East Coast Operator of Last Resort on 1 May. When I asked DfT Rail where the force majeure claim has got to the reply was ‘We've received a claim from GNER and are considering it'. After a long career across a wide spectrum of industries, in addition to the railways, I could see a decision on this claim taking until at least, oh, 2 May, to resolve.

Finally, turn back to Table 1 at the start of this month's column and you will see that I have done a similar calculation for South Western. And assuming Network Rail's total income (Track Access Charges plus Direct Grant) falls during the next control period, South Western could be generating a genuine premium by 2012.

Continues.........