March 22, 2012

Can decentralisation pull Britain's railways into line?

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Last month the British government issued its command paper on the future of the country’s railways, which set an ambitious target of cutting costs by £3.5bn by the end of the decade. Keith Barrow examines the proposals, and how the industry is preparing for the challenge.
THE publication last year of Sir Roy McNulty's Rail Value for Money Study threw into sharp focus the inefficiency of Britain's railways. Despite substantial growth in passenger numbers and freight volumes following privatisation in the mid-1990s, rapidly rising costs have made this one of the most expensive networks in Europe, and with the prospect of traffic doubling by 2030, few question the need for urgent reform.

Last month the coalition government issued its formal response to McNulty, a command paper setting out its objectives for the rail industry over the rest of the decade. The paper supports McNulty's view that the industry should seek to achieve annual efficiencies of £3.5bn by 2019, which means cutting unit costs by 30% from 2008-09 levels without reducing the size of the network or raising fares beyond what is already planned.

In line with the government's localisation strategy, decentralisation is a key theme of the command paper, which sets an agenda for transferring operational decision-making, and even some strategic functions, to the people running the railway. This means a much smaller role for the Department for Transport (DfT), which since the abolition of the Strategic Rail Authority in 2006, has been responsible for governance of the industry. The command paper seems to support the view of many DfT critics, who have argued the department has too much influence over the day-to-day running of franchises and rolling stock policy.

"The industry has not always been ready, or at times permitted to show the necessary leadership," the paper states. "The government became too involved in the detail of the industry on too many occasions, for example on issues of train service specification and deployment of rolling stock. The result is that the government is seen as holding much of the responsibility for the industry's performance, as well as many of the risks."

The command paper makes it clear from the outset that the government does not advocate another round of major structural reform, and the existing franchise system, which is still supported by all three main political parties, will remain. However, significant changes are proposed. Fourteen of the 18 existing franchises are due to be re-let by the end of 2016, and the government says these will be of a longer duration than existing contracts, giving operators more responsibility and flexibility in how services are run (particularly for long-distance services), and more incentive to invest.

The command paper outlines plans to scrap the so-called ‘cap-and-collar' arrangement, under which the government is contractually obliged to provide revenue support to operators affected by wider economic forces, arguing that this system insulates franchisees from over-ambitious bids and unrealistic revenue forecasts.

This means that in future, the government will seek new forms of sharing external risks with franchisees. The new West Coast franchise for instance will index-link premium payments to GDP, although the government says it is willing to consider payments linked to other economic variables.

The command paper notes that the existing franchise system largely removes operators' exposure to infrastructure costs, meaning they had little incentive to work with infrastructure manager Network Rail (NR) on cost reduction. To address this, the government plans to incentivise partnerships that identify and generate efficiencies, such as the alliances already being established by NR and passenger operators. By the start of the next NR five-year funding period, which begins in April 2014, the government and the Office of Rail Regulation (ORR) will develop incentive mechanisms that will be built into track access and franchise agreements.

For the infrastructure manager, the publication of the command paper comes just a few months before the government is due to reveal its funding settlement and targets for 2014-2019. NR has reduced costs substantially in the current funding period, and will be under pressure to go much further in the next.

In the command paper, the government acknowledges that the centralisation of infrastructure management was necessary to bring safety and performance up to the required standard in the wake of the Hatfield derailment in 2000, which led to the collapse of NR's predecessor Railtrack. However it notes that a change of direction is now required to exploit opportunities for further efficiencies at a local level.

NR is already responding to this, and in February 2011, before the McNulty study was published in full, it revealed plans to devolve day-to-day decision making on the operation and maintenance of the network to local managers. Under this structure, the network is divided into 10 routes. Each route is under the jurisdiction of a route managing director, who has authority to take decisions, is expected to act quickly, and has control of how the territory is run.

"NR had become quite centralised, and railways don't work like that, you have to take decisions close to the customer," Mr Robin Gisby, NR's network operations director said at the recent Rail Industry Reform conference in London. "By 2014 the core of NR will be much smaller and the routes will be the powerhouse of the railway."

The routes' responsibilities include:
  • safety
  • customer relationships
  • access planning
  • operation of the network
  • asset management (maintenance/renewals), and
  • delivery of local enhancement projects.

From April 1, the routes will also take control of their own budgets, and this represents a significant proportion of NR's expenditure.

NR's national network operations centre will support the routes, and retains functions that need to be managed centrally, including timetabling; maintenance development; operating strategy; freight; stations and commercial policy; and performance analysis and reporting.

The routes are expected to develop their relationship with train operators by forming alliances, a process which has already begun. The Wessex route southwest of London has some of the most intensive passenger operations in the country, and NR is developing an alliance with operator South West Trains in an effort to integrate track and train more closely.

"We're sharing every number, and every risk on revenue and costs, and at this stage it feels like the right way to go," explains Gisby. "Some people have questioned the duplication of functions within alliances, and the number of interfaces, but actually the cost of that is tiny compared with the savings in operational expenditure."

Just how far NR and the operators go with alliances will depend on local conditions, and Gisby stresses that what works in Wessex, where one operator dominates, will not be appropriate everywhere. Future franchises will therefore be designed to allow bespoke cost and revenue sharing between NR and operators, and this could cover major enhancement and renewal projects. The development of these arrangements is therefore largely in the hands of the industry.

The ORR is currently studying the regulatory implications of alliancing, without compromising the needs of smaller operators including freight companies, but it broadly welcomes the concept. "We support NR's role and we're delighted to see the development of alliances," says ORR chief executive Richard Price. "Our requirements on alliances will not be onerous, but we want to focus on transparency and fairness so other operators are not excluded."

NR may go beyond alliancing and let infrastructure concessions on "discreet parts of the network," with Wessex and Anglia highlighted as potential examples. But while the government has welcomed this proposal, not everyone favours a return to vertical integration. The Rail Freight Group (RFG) has pledged its support for alliances but opposes concessioning on even a trial basis. "We are not prepared to see freight operators and their customers compromised by full vertical integration experiments, which experience elsewhere has shown to be detrimental to competitive freight growth," says RFG chairman Lord Tony Berkeley. "We urge the DfT to reconsider its support for such changes."

The government also plans to elevate local authorities to a more prominent role in specifying local rail services and investment. The command paper suggests that local authorities and transport bodies in the major conurbations are best placed to identify the local trends that drive passenger demand.

However, it acknowledges that complex issues would need be addressed. In some areas, such as northern England, where there has been huge growth in regional rail travel, the current political structures do not match the operational geography of the franchises.

"A new approach is clearly needed, and we must recognise the role of rail in the northern economy," says Transport for Greater Manchester rail programme director Mr Stephen Clark. "There is a complex political landscape in the north, but northern cities and local authorities have a very strong common case for rail improvements based around shared economic objectives. There is unanimous support for projects like the Northern Hub and High Speed 2."

The command paper suggests some decentralisation options might involve transferring significant revenue risk to local authorities. "Some parties will be willing to take these risks, others won't, so the governance model needs to reflect this," says Clark, who suggests a single rail executive for the north could bring these interests together.

The government has accepted McNulty's recommendation of a fares review, which will examine the broader rollout of smart card technology, and simplification of the current, and bewilderingly-complex fares structure, with the aim of making the system fairer and easier for passengers to navigate.

This review will also look at how demand can be spread more evenly outside the peaks. The command paper argues that "failing to optimise the use of capacity means we may be placing more strain, and more costs on the network during peak periods than are really necessary," and suggests that encouraging passengers to travel outside the peak would make better use of existing capacity and therefore potentially defer investment in new trains and infrastructure on some routes. The government says it will look at rewarding passengers who travel in the shoulder-peak period, although it might be argued that large-scale "smoothing" of the peaks might only be possible with a commitment from the business community to more flexible working hours or more home working.

Many of the themes in the command paper seem to hint at recapturing something that was lost with privatisation. The restructuring of British Rail in the late-1980s into business sectors, each with its own budget, revolutionised the economics of the railway, delivered customer-focused innovation, and improved the bottom-line at a time of economic hardship and declining public subsidy.

With similar challenges facing the industry 20 years on, it is no coincidence that some of the key figures behind that transformation now argue strongly in favour of devolution. The enthusiasm for alliances and cross-industry commitment to the Rail Delivery Group (RDG) suggests that operators and NR are also keen to regain that customer-oriented focus.

Equally however, one is left with the feeling that the command paper adds little flesh to the bones of the McNulty report, and sidesteps some critical issues that have long-term implications for the industry, such as the highly-contentious £4.5bn Intercity Express Programme. It is vague on how it expects longer franchises to encourage more investment, beyond simply giving operators more time to recoup what they spend. And while the government is clear on what it wants the industry to achieve, it offers little guidance on what role its own institutions, in particular the DfT, should play in that process.

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