The earliest recorded private pit railway in Britain was built at Wollaton near Nottingham in 1604 by Huntingdon Beaumont; he subsequently took the idea north and by 1660 perhaps nine such railways existed on Tyneside. The railway thrived in the Tyne coalfields and technical developments were exported to other fields in Yorkshire, Cumberland and Scotland. Simultaneous with the Tyneside system, railways were developed in Shropshire; from 1665, these railways spread through the West Midlands, Wales, Lancashire and Scotland. Thus, the oldest rail network in the world was born; a patchwork of local rail links, operated by small private railway companies.
By the mid-1840s, however, the Industrial Revolution was creating a new, increasingly-affluent middle class. While earlier business ventures had relied on a small number of banks, businessmen and wealthy aristocrats for investment, a prospective railway company now had a large, literate section of population with savings to invest. Railways were heavily promoted as a foolproof venture. New media such as newspapers and the emergence of the modern stock market made it easy for companies to promote themselves and provide the means for the general public to invest. Many families invested their entire savings in prospective railway companies.
The British Government hardly regulated the railways. Companies had to submit a bill to Parliament to gain the right to acquire land for the line, which required the route of the proposed railway to be approved, but there were no limits on the number of companies and no real checks on the financial viability of a line. Since many MPs were heavy investors in such schemes, it was rare for a Bill to not pass. A self-promoting cycle based purely on over-optimistic speculation spawned.
Boom and Bust
As it became clear that the lack of regulation had produced numerous impotent entities, investors began to realise that railways were not all as lucrative and as easy to build as they had been led to believe. In late 1845 the Bank of England put up interest rates, enticing investors with the comparative security and guaranteed return offered by Government bonds. As investment flowed into such bonds, money began to pour out of railways. The growth of railway’s share-prices slowed, levelled out and then began to fall. Investment halted virtually overnight, leaving numerous companies without funding. The larger railway companies such as the Great Western Railway began to strategically buy up failed lines, in order to expand their network; shareholders were forced to choose between an offer that greatly under-valued their business, or the total loss of their investment. By the early 1850s, the only new lines constructed were financed by the large companies.
The competition from road transport during the 1920s and 1930s greatly reduced the revenue available to the railways, despite the increased need for maintenance on the network. Rail companies accused the Government of favouring road haulage through the construction of roads subsidised by the ratepayer, while restricting its ability to use flexible pricing because it was held to nationally-agreed rate cards. Although road pricing changes introduced in response aided their survival, the railways entered a period of slow decline, owing to a lack of investment and changes in transport policy and lifestyles.
During the Second World War, the rail industry effectively operated as one company, in order to assist the country's 'war effort'. This commitment put a severe strain on the railways' resources and a substantial maintenance backlog developed. Incoherence, inefficiency and a failure to innovate, created pressures which eventually led to the nationalisation of the railways through the Transport Act 1947.
Through increased usage and despite few initial changes to the service, the network became profitable. A program of track and station regeneration was completed by 1954. The mid-1950s also saw the hasty introduction of diesel and electric rolling stock to replace steam, in a modernisation plan costing many millions of pounds, yet this could not stem the migration of traffic from rail to road. Rail revenue fell and in 1955 the network again ceased to be profitable; these failures lead to restricted investment and extensive cost-cutting. During the 1960’s, Dr. Richard Beeching was tasked to oversee a major reduction in the rail network, in search of profitability. The closure of stations serving rural communities removed much feeder traffic from main line passenger services. The closure of many freight depots that had been used by larger industries such as coal and iron led to much freight transferring to road haulage. Passenger levels decreased steadily over the next decade. British Rail also came to be criticised for a failure to deliver an effective, innovative and value-for-money railway system. These criticisms culminated in the Railways Act 1993 which started the process of re-privatisation. Ownership of the track and infrastructure passed to Railtrack; passenger operations were franchised to individual private sector operators and the freight services sold outright.
Privitisation
The original objective of rail privatisation and the creation of franchises was to re-introduce competition and thereby, it was hoped, increase efficiency and innovation, enhance responsiveness to the needs of passengers and freight customers, lever private investment in to the railways, reduce the level of public subsidy and to harness private sector commercial judgment and innovation to reduce the net cost and increase the value for money achieved from the Government’s overall support for passenger rail services These objectives have not changed substantively since privatisation although the Government has acknowledged that, unlike some other privatised utilities, the railways are a public service which will always depend on substantial public subsidy.
In July, National Express agreed to hand-back its £1.4bn London-to-Scotland ‘East Coast Mainline’ rail franchise back to the Government. The firm's refusal to continue funding the loss-making East Coast Main Line beyond the next few months, leaves the service in the hands of the publicly-owned East Coast Main Line Company, announced by Transport Secretary Lord Adonis recently. Operations are set to continue with "no disruption of services". Indeed this very public failure follows on from the demise of the previous operator GNER just 18 months before. In 2005, GNER won the right to retain the East Coast franchise, operating between London, Leeds and Edinburgh, for ten years. It pledged to pay £1.3 billion to the taxpayer in premiums over the life of the franchise, thought to be £300 million than the sum bid by VirginRail, the runner-up in that franchise competition. The margin of victory in that contest alone suggests a staggering over-bid by both GNER and its successor National Express.
GNER highlighted tension between the interests of the Government and those of many passengers and local communities, as the reason for their demise, when saying that the franchising system “provides the best value operator for the Government’s specification of a particular route, although this is not necessarily the same as providing the best value for the passenger or the railway.” A 2006 report by the Commons Transport Committee concluded with a damning assessment of the franchising system, describing it as: “little more than a complex, costly and mediocre means of maintaining the status quo.”
“The Government has embraced the notion that private enterprise is best at delivering high-quality, innovative services such as the passenger railways and yet it does not trust companies to deliver these services without highly detailed and specific contractual requirements which reduce the scope for innovation. It supports competition and yet appears to see open access operators as a threat to stability. It wants risk to be transferred from the public to the private sector - yet risk cannot be transferred in anything other than name because no Government could afford to let the railways go bust. The Government hails the growth in passenger patronage - yet it does not provide the long-term strategy and investment to increase capacity on the network. It wants coordination and yet continues to operate a system of fragmentation. It wants the private sector to invest, take risks and innovate and yet it prioritises price above all of these. There is scant evidence that the current model balances and optimises the benefits from conflicting priorities.”
The key objective of the rail network over the next few decades must be to increase capacity and facilitate growth in patronage through improvements in services to passengers. The only way to achieve this in the long term is to drop the dogmatic pursuit of competition where competition is not possible and to make honest and tough choices about what the private and public sectors can and should do in future. There must be a strategy in place, capable of securing quality passenger rail services to meet rising demand over the next half a century.
The service that cannot go bust
The very notion of a franchise agreement centres on the ability of the franchisor to transfer risk to the franchisee; without this, according to John Segal of MVA consultancy, there is little incentive to see out a contract. “Some risk is borne by the operators but it is a relatively small amount. They have potentially £30-£70 million invested in this – no more. If it is making £400 million turnover, that is a hugely small investment and they can walk away from it if necessary. They lose some credibility but they can walk away. The Government would have to make sure the train services run and it can re-franchise and re-let it.”
There is significant evidence to suggest that risk is not transferred to the private sector, as one might have expected, particularly track access charges and the cost of industrial action. In the case of track access charges, the Government insulates franchises against increases in Network Rail’s fees for accessing the track by adjusting premiums or subsidies to take account of any changes in access charges. The Government also compensates franchise operators for losses incurred in the cost of industrial action incurred. The transfer of risk to the private sector is also highly inconsistent. Given the high level of risk borne by the Government in areas such as track access charges and industrial action, it appears strange that franchising companies are left to bear the risk of open access operators affecting their revenue without any assistance from the Government. Changes to franchise contracts in recent years have served to reduce the risk exposure of Train Operating Companies (TOC’s) still further. These changes are an attempt to minimise the risk for the Government of operators getting into financial difficulties and seeking to re-negotiate the terms of their contracts part-way through the franchise. Franchise contracts now generally include “revenue risk-sharing mechanisms”, also known as “cap and collar protection”. This typically means that after the first four years of the franchise contract have passed, 50 per cent of any fares revenues in excess of 102 percent of the TOC’s original forecast are shared with DfT and DfT makes a contribution equivalent to 50 per cent of any revenue shortfall below 98 per cent of the TOC’s original forecast - for any shortfall below 96 per cent, DfT’s contribution increases to 80 percent.
In the past, a significant number of franchise contracts have been re-negotiated part-way through their term because franchise operators have found themselves in financial difficulties. Yet more recently the Government has been adamant that it will no longer re-negotiate contracts under any circumstances and that it is prepared to see an operator go to the wall rather than renegotiating contractual terms. This resolve has now been seriously tested with Lord Adonis forced to confirm [in respect of National Express]: “the Government does not renegotiate rail franchises.” Such action became inevitable since a number of operators have entered into high premium contracts on the basis of over-optimistic growth forecasts. GNER lost the East Coast franchise in 2007 after it became clear that the growth projections upon which it agreed to pay £1.3 billion for the East Coast Main Line franchise just 18 months previous, were unrealistic.
The practice of renegotiating contracts effectively meant that the Government was underwriting franchise operators in the past. This is the ultimate form of risk retention by the Government. Having re-designed franchise contracts to include ‘revenue risk-sharing mechanisms’, it is crucial that the Government resist any pressures to renegotiate franchise agreements if operators get into difficulties. The risk to the Government is potentially compounded by the fact that the concentration of the market means that a few large companies increasingly run multiple franchises. In an oral statement to the House of Lords on the 1st of July, Lord Adonis suggested that National Express: “has said that it does not intend to default on its obligations in respect of [the remaining] franchises. Notwithstanding this, the Government believes it may have grounds to terminate these franchises and we are exploring all options in the light of the Group’s statement.”
If the Department for Transport were to use the cross-default principle, as this suggests, whereby a franchise operator that runs multiple franchises will lose all its franchises where it fails to fulfil its obligations in one of these, the Department could be left with a significant financial and management problem. The concentration in the market also means that, in such situations, it might be difficult for the Government to find bidders able and willing to take on a whole series of franchises removed from a failing incumbent at an acceptable price.
The transfer of risk to the private sector was a core objective of privatisation. But in the current system only a very limited proportion of risks are, in reality, borne by franchise operators. There are also significant inconsistencies regarding the risk borne by operators and that borne by the Government. The relative lack of risk-transfer, calls into question the fundamental assumptions and objectives of the franchising system. If risk is not transferred, there is little point in involving the private sector in the running of the railways…