3 - Procuring rail passenger services
3.1 The Scottish Ministers have responsibility for procuring rail passenger services which operate wholly in Scotland. There is currently one contract, a rail franchise, operated by First ScotRail, and this is due to end in November 2014.
3.2 The rail infrastructure is managed by Network Rail. For financial planning purposes Network Rail works within five-year 'Control Periods' each one beginning on 1 April and ending on 31 March to coincide with the financial year. The next control period starts on 1 April 2014. Prior to the commencement of the next control period we will issue our High Level Output Specification which sets out what we would like Network Rail to achieve during that period.
3.3 We are therefore currently considering how to procure and supply rail passenger services from 2014, and what we would like Network Rail to achieve from that point. This consultation will inform our choices.
3.4 Since privatisation in the mid 1990s, Scottish rail passenger services have been contracted through two franchises.
- Franchise 1 - The National Express Group became the first franchise holder in April 1997, holding the contract until October 2004. The contract was issued by the Office of Passenger Rail Franchising with the involvement of SPT for services in the Strathclyde area.
- Franchise 2 - This is the current franchise and is operated by First Group. The contract was let by the former Strategic Rail Authority (SRA) following Directions and Guidance issued by the Scottish Ministers in 2002. The contract came into effect in October 2004 and was originally let for 7 years with an option for a three year extension. The Scottish Ministers assumed responsibility for managing and monitoring the ScotRail Franchise as a result of the Railways Act 2005. On 2 April 2008 the Scottish Ministers executed the extension option in the contract, so the contract expiry is now 2014.
3.5 The Scottish Ministers are now responsible for the letting of the future contract for rail passenger services.
Options for the future
3.6 The current legal framework puts a number of constraints on how we might provide rail services in Scotland:
- The European Union's First Rail Package requires a degree of separation between the organisation which operates the rail infrastructure and the organisation which operates the rail passenger services. It also requires that there is a level of separation between both these organisations and government.
- Under UK legislation the Scottish Ministers and any other UK public sector bodies are statutorily prevented from providing designated passenger rail services. However, there is no corresponding statutory ban on foreign public sector bodies being able to bid for and operate UK franchises.
- In addition, under UK legislation, the rail passenger services funded by the Scottish Ministers can in practical terms only be provided through a franchise. The Scottish Parliament does not have the power to change this UK legislation.
3.7 Whilst we would have liked to have been in the position of at least having a range of options available to us, we have concluded that, under prevailing legislation, we are limited to contracting for rail passenger services by means of a franchise. Consequently, we cannot plan to operate the franchise as a state enterprise or enable or support other Scottish public sector bodies to provide rail passenger services.
Franchise or management contract
3.8 Although the legislation in practical terms requires a franchise to be put in place, it does not state what model or form the franchise should take.
3.9 A franchise is a form of contract. The contract can specify how the party providing a service, in this case rail passenger services, is to be rewarded for the provision of that service. That reward could be made in the form of a one-off fee (similar to a standard management contract) or by taking a share of the profit (the standard rail franchise).
3.10 The way we frame the contract or franchise could be, for example, as:
- a standard GB-style rail franchise, where the party supplying the rail passenger services pays a premium, or takes all or some of the operating profit
- a management contract, where the party supplying the rail passenger services receives a management fee instead of taking its income in profit
- 3.11 There is no presumption that the party supplying rail passenger services cannot be a mutual or a co-operative.
- 3.12 We are currently considering options for the framing of the contract or franchise and would be interested in your views.
Multiple franchises / operators
3.13 There is no statutory limit to the number of franchises that could operate in Scotland. ScotRail could be subdivided along lines that would create geographically or operationally distinct franchises, for example, the sleeper services, regional routes, all or some inter-urban services (such as Edinburgh - Glasgow). We are currently considering whether the Caledonian Sleeper Services, for instance, should be offered as a separate franchise, and further detail can be found in Section 11 of this document.
3.14 As well as having a number of franchises it would also be possible for those franchises to apply different types of operation. This could include, for instance, different levels of service specification within a single franchise. We think that having a single franchise of multiple service specification would allow us, for example, to define services where we consider there is a social requirement for their existence, whilst also allowing the franchisee to determine and develop the service requirements of the more commercial inter-city and commuter network. If this approach was taken the ScotRail franchise would be operated as two managed units:
- 1. Economic rail - the provision of services where the commercial risk is borne by the operator, where industry would be willing to invest, and where the industry would be given freedom to change its operations in response to demand. In order to safeguard passenger interests the operator would have to comply with a number of requirements and a minimum service specification. It is likely that the inter-city routes and some of the commuter routes would fall into this category.
- 2. Social rail - the focus for the provision of the services falling within this category will be to achieve particular social objectives, for example, economic and social stability in a particular locality, or to assist with regeneration. These services would be distinctly managed for a fee in accordance with social objectives to address local circumstances. There would be greater opportunities for community involvement in the specification of services, and local communities would be able to support the challenge of reducing the gap between revenue income and subsidy. It is likely that most of the rural lines would fall into this category.
3.15 The two managed units as outlined above would clearly require different incentives and safeguards. However, whilst being managed and reporting for different outcomes, we would not wish to have two separate and distinct railways. The ScotRail services would be one operation, contracted through a single franchise, where the franchisee is able to maximise the opportunities and flexibilities in meeting our objectives for economic and social rail.
3.16 The dual-focus franchise proposition, as outlined above, could be a significant contribution to achieving our objective of incorporating the best private sector attributes with public sector ethos in the provision of rail passenger services in Scotland.
3.17 We welcome views on the number and extent of franchises and the merits of our proposition for a dual-focus franchise covering economic rail and social rail.
Length of contracts
3.18 There has been a call from the train operating companies to extend the length of franchises, in order, the companies say, to make it more attractive to invest in developing the rail network. However, there is no conclusive evidence that longer contracts will increase the level of investment from train operating companies. Indeed, it could be argued that shorter franchises ensure the testing of the market more frequently and therefore improve competitiveness. In addition, other mechanisms could be built into a short franchise, such as making allowance for residual asset value, so as to encourage investment from the franchisee.
3.19 We are mindful that the coming years are likely to bring significant organisational and operational change across the industry as it rises to the challenges identified in the McNulty report. Over the same period there may also be, particularly for Scotland, significant constitutional changes. Accordingly, we welcome views on the merits, or otherwise, of proceeding with a short-term franchise.
3.20 We are considering whether there is merit in providing opportunities for third parties to promote enhanced rail services and facilities, provided that these do not adversely impact on the operation of the franchise, and are funded by the promoter for a specified period of time. At the conclusion of a specified period the service or facility could either be incorporated within the franchise, continue to be funded by the promoter or withdrawn. We are considering whether such an approach may encourage additional investment and welcome views on the merits and practicalities of such a proposal.
Franchising Policy Statement
3.21 In preparation for any re-franchising process, the Scottish Ministers are required under section 26 of the Railways Act 1993 to publish a Franchising Policy Statement. This sets out how we propose to exercise our powers in selecting a person who will provide passenger rail services under a franchise agreement. A draft statement was therefore issued for consultation in August 2010 and responses were published on the Transport Scotland web site in December 2010. That consultation raised a number of issues which we would wish to address through this more extensive consultation. Therefore we have decided that the formal Franchising Policy Statement will be published in early 2012, after this consultation has been concluded.
Stages of the franchising process
3.22 The process of letting a franchise can take some time. The indicative time-frame for letting the next franchise is set out in Table 3.
Table 3: Stages of the franchising process
|Specification – this sets out what the government requires from its franchise contract. This consultation will feed into this activity.
|Base Case Comparator Model – the government creates this model so that it can determine the likely cost of its specifications
|Pre-market consultation – the government starts talking to the market so that there will be a number of appropriate bidders in order to conduct a meaningful competition
|Announcing the intention to franchise – the government issues
- a franchising policy statement
- issues a notice in the Official Journal of the European Union
- invites companies to fill in pre-qualification questionnaires
|Pre-Qualification – the government marks the Pre-Qualification Questionnaire issued to potential bidders in order to determine those who are qualified to participate in a formal tender
|Competition – the government issues an invitation to tender to qualified bidders, inviting tenders and subsequently marking those tenders which are evaluated against the Base Case Comparator Model
|Contract award – the government awards the franchise to the most appropriate tender
|Mobilisation and Operation – the selected contractor prepares to take over, 6 months prior to start of contract, and the contract and new services is launched
||April - November 2014
3.23 Once we have concluded our policy considerations and determined how we wish to see the rail network developed and what rail passenger services should be provided, we will be drawing up the High Level Output Specification for Network Rail and the requirements for the next franchise contract. As part of that work there are a number of contractual issues that we will need to address and on which we would welcome views:
3.24 How the franchise contract is specified affects how the franchisee operates. A franchise can, for instance, be heavily specified with a large range of inputs. This could cover specifying how many services must operate between stations and include details of journey times, frequencies, times of day, and carrying capacity. The Association of Train Operating Companies has argued that there should be less detail in the contracts so as to enable operators to be more innovative.
3.25 We are keen to adopt a more outcome-based approach to the franchise, where through the franchising process bidders provide details of the costs of delivering the outputs rather than the actual cost of specified inputs. Accordingly, we need to determine the key outputs that we would require from the franchisee. Since we wish to place passengers' interests at the heart of rail passenger services we are considering a mix of passenger satisfaction measures as output measures. However, we are also keen to ensure that we obtain value for money. We believe that an output-based approach will focus the franchisee's attention on delivering improvements that matter to the passenger.
3.26 We will therefore need to design a contract which incentivises a franchisee to earn revenue against a set of contractually binding service measures. These could, for example, focus on the quality of stations, trains, information provision and customer service, as well as matters relating to crowding and punctuality. By focussing on outcomes we expect the franchisee to innovate to deliver efficiency improvements and thereby reduce the cost of providing rail services and the level of subsidy.
3.27 We welcome views on this outcome-based approach including what measures we should apply, and how we can incentivise the franchisee to achieve these outcomes whilst reducing the cost of the franchise to the taxpayer.
3.28 Franchise revenue is dependent on a number of factors: the performance of the wider economy; fares charged, and direct measures taken by the franchisee to increase patronage and/or operate more efficiently. We are determined to ensure that any future franchise offers the best possible value for money to taxpayers and passengers.
3.29 In general, under a franchising regime, a franchisee would be expected to take revenue risk. In other words, in the case of a railway franchise, if revenue from fares is not as high as expected, the franchisee, and not the Government, would be expected to absorb any financial impacts. However, we recognise that the general state of the economy, as characterised by Gross Domestic Product (GDP) growth, may have a significant bearing on revenue and a downturn in GDP will be largely outside the control of the franchisee. We are therefore considering whether some form of risk support should apply if revenue growth is substantially less than forecast, which could threaten the overall viability of the franchise.
3.30 We recognise that the ScotRail franchise is a heavily subsidised franchise and therefore any Government support for risk may potentially increase the taxpayer's contribution beyond current levels. We may invite potential franchisees to bid for the contract based on a number of levels of risk. Accordingly, we acknowledge that any decision on risk will be intrinsically linked to requirements of performance bonds or parent company guarantees.
3.31 We welcome views on the principle of risk support and on appropriate mechanisms for setting the level of risk support, and how this can be reflected in the tendering process.
3.32 We are also keen to ensure that the taxpayer will benefit if the increased profits of a franchisee are as a consequence of macroeconomic and local economic growth rather than solely good management by the franchisee. We may invite potential franchisees to provide details of how they will determine what profit growth was due to the effects of the wider economy and what was due to their own actions. We may also look for a profit-share system, where at a certain point the Scottish Government would receive a share of profits generated by the franchisee.
- Performance Bonds and Parental Company Guarantees
3.33 Under the current franchising arrangements the ScotRail franchisee is required to hold performance bonds or parent company guarantees. These instruments ensure that the franchisee fulfils its commitments, and does not breach the terms of the franchise.
3.34 Performance bonds are held by the franchisee with commercial bond providers. In the event of the franchisee defaulting on the terms of the franchise, we can call on the amount of the bond to cover the costs of refranchising. The franchisee pays a premium to the commercial bond provider for the service. The level of the premium is determined on a risk basis and we currently pay franchisee enough to cover this premium as part of the overall franchise payment.
3.35 Parental company guarantees are a contractual undertaking that the owning company will put a specified amount of additional money into a franchisee that is failing financially, in order to prevent or postpone default on the franchise. The guarantee therefore acts to ensure that the parent company is at financial risk for substantial sums in the event that the franchise does not operate to the terms as agreed.
3.36 In short, performance bonds and parent company guarantees seek to address risk. However, the financial sums involved can be quite substantial and can have a bearing on the competitiveness of bids. If the bond market and the Government respectively set the performance bond or parental company guarantee too high then franchise bids will be uncompetitive as bidders merely seek to defray costs by requesting, in effect, larger subsidies. High performance bond levels could also prevent or discourage potential classes of bidders such as mutuals or co-operatives. However, if we set the level of performance bond or parental company guarantee too low we place the taxpayer at risk should a franchise default.
3.37 We welcome views on the role and level of performance bonds and parent company guarantees, and whether we should consider other mechanisms or sanctions. Our aim is to ensure that the risk of default is managed in a way that does not add substantial cost to the bid nor prevents organisations bidding but protects the interests of the taxpayer.
||What are the merits of offering the ScotRail franchise as a dual focus franchise and what services should be covered by the economic rail element, and what by the social rail element?
||What should be the length of the contract for future franchises, and what factors lead you to this view?
||What risk support mechanism should be reflected within the franchise?
||What, if any, profit share mechanism should apply within the franchise?
||Under what terms should third parties be involved in the operation of passenger rail services?
||What is the best way to structure and incentivise the achievement of outcome measures whilst ensuring value for money?
||What level of performance bond and/or parent company guarantees are appropriate?
||What sanctions should be used to ensure the franchisee fulfils its franchise commitments?