RAIL 819: TOC ownership heads abroad

Back in late November 2014, when the c2c franchise was awarded to National Express, I attended a press briefing about the new deal at which significant new and interesting passenger benefits - automatic compensation payments, for example - were unveiled.

In the discussion, I pointed out that National Express was now operator of a single, modest franchise, and therefore appeared to be on its way out of the UK franchise business? This very large owning group had operated 12 TOCs (not all at the same time): c2c, East Coast, ScotRail, West Anglia Great Northern, ‘one’, Gatwick Express, Silverlink, Central Trains, Midland Mainline, Wales & Borders, Valley Lines and Wessex Trains. My question was contemptuously brushed aside by a senior National Express manager. But just over two years later, NX has indeed thrown in the towel on UK passenger operating.

What was interesting was not merely NX’s departure, but to whom c2c, which has 12 years left to run, was sold: Trenitalia. Thus, Italy’s state railway joins SNCF (France), DB (Germany) and Abellio (Netherlands) as a British franchise holder. And the overseas involvement doesn’t end there: MTR (Hong Kong) is already operating TfL Rail and is ambitious for more - it has joined First to bid for South West Trains. Meanwhile, Japan’s JRE and Mitsui are jointly bidding for West Midlands with Abellio, while Trenitalia has joined with First to bid for both West Coast and East Midlands. Mitsui has recently taken a 40% share in Anglia, with Abellio. 

As Wolmar points out (pages 68-69) the only UK owning groups now are Virgin, Stagecoach and First. And as the last two are Scottish, that leaves only Virgin as an owning group based in London. Up to 2003, 20 TOCs were owned by UK companies and only three were in overseas hands. By 2014, 14 TOCs were owned by overseas companies while only six were UK-owned. Within a couple of years, the UK could be represented at the Railway Delivery Group with France, Germany, Italy, Netherlands, Japan and Hong Kong. The direction of travel is clear - but why is this and what are the implications? Is it necessarily a bad thing? If this rainbow alliance gives us great railways, does it matter? The answers involve hard fact, a good deal of emotion, national feeling and - inevitably - politics.

Firstly, why has this happened? After a few years in the late 1990s when a good deal of entrepreneurial flair was accompanied by what can only be described as ‘gaming the system’ and some poor performance by TOCs, the erstwhile Strategic Rail Authority started tightening the screws. And so rail franchises gradually became more prescriptive and the room for the private sector to ‘buckle its swash’ was progressively eroded on the one hand, while costs went up on the other - with a consequent squeeze on margins. 

This wasn’t too much of a problem at first, as it seemed that owners put up with the tightening grip in return for consistent margins of maybe 4%-5%. But this trend has continued such that average train operating profits have declined to an average of 1.9%. Increased risks through significant bonds held by the DfT in case of failure are a further heavy burden. Cynics might say that the only way to win a franchise now is to submit a bid that may be impossible to deliver. A franchise owner has to gamble that there won’t be a shock to the economy that will shatter fragile franchise finances. Add the heavy cost of lost bond payments if you hand back the keys and it maybe isn’t surprising that National Express has said ‘enough’. 

Government wants the private sector involved, but has squeezed margins to less than 2% on average, ramped up the cost of failure, and all-but eliminated any room for innovation or entrepreneurial flair to earn more corn to make up for any unexpected shocks. 

So why are overseas state railways so interested? Do the same risks not apply to them? Well, yes. But given these companies are state-backed with deep pockets, they do not ‘feel the risk’ in the same way as private sector bidders. And those risks are still increasing. For a long time, the received wisdom was that franchise bids cost around £5m - and the DfT routinely not unreasonably wanted four-bidder shortlists. Some time ago, bidding costs were being quoted as £8m-£10m and I said at the time that I did not believe that private sector shareholders would tolerate such costs - especially for sub-2% profits in the context of increasing risk. The fact that the UK private sector is in retreat would seem to bear this out. Where UK companies are involved, they are often involved alongside a European state railway bidder (Arriva with DB, Keolis with SNCF) to share that risk. Government-backed state railways are both better able to share that risk and are prepared to accept low margins. 

Is all this a bad thing? Personally, I think the balance is shifting too far and that we do need more UK owning groups involved - and I believe that is very much in the DfT’s interests, too. Because it’s not just about money, it’s very much about politics. And the heat is already on, not least within the trade unions, about overseas state railway involvement (again see Wolmar, pages 68-69). Increasing foreign ownership of TOCs - especially in the febrile and isolationist Brexit context - is potentially incendiary for Government. Those who advocate nationalisation will find fertile ground for their arguments here - and Government could find it pushed increasingly in the direction of public ownership. It isn’t the answer - it would be disastrous. Nationalisers who point at the East Coast publicly-owned experiment should listen to former Chairman Michael Holden, who ran it. He said that the amount of management time dealing with Government was ruinous and that EC worked despite being part of the public sector, not because of it. In RAIL 818 we debunked the myth that fares could be slashed if we stopped exporting millions of pounds in profits. You’d get a 2% cut, just once. The truth is rather different. On ScotRail, every penny of profit generated by Abellio has been retained (I understand) in Scotland. Moreover, there has been a further £25m investment by Abellio. Regarded thus, the net flow of cash is in, not out, of Scotland!

This trend towards overseas state railway ownership of our franchises is undeniable, and the DfT must decide if it wants this trajectory to continue. If it doesn’t, it must act. Franchising isn’t broken (as some would claim), because Managing Director of Passenger Services Peter Wilkinson is not only known for his notorious Croydon comments that so inflamed the SR strike, it is less widely appreciated that he has also built some very welcome major passenger benefits into the contracts he has negotiated, for which he deserves credit. 

It’s my belief that overseas TOC ownership needs to be better balanced with UK-based companies. Only the DfT can achieve this.

Comment: RAIL 819: February 1 2017 - February 14 2017