Public Accounts Committee

Oral evidence: Reform of the rail franchising programme, HC 600

Wednesday 2 December 2015

Ordered by the House of Commons to be published on 02 December 2015

Watch the meeting: http://parliamentlive.tv/Event/Index/ad4abd72-7d13-452a-bb07-615c77ba4b74

Members present: Meg Hillier (Chair), Mr Stewart Jackson, Nigel Mills, David Mowat, Stephen Phillips, John Pugh, Karin Smyth, Mrs Anne-Marie Trevelyan

Sir Amyas Morse, Comptroller and Auditor General, Adrian Jenner, Director of Parliamentary Relations, National Audit Office, Rebecca Sheeran, Director, National Audit Office, and Marius Gallaher, Alternate Treasury Officer of Accounts, were in attendance.

Witnesses: Philip Rutnam, Permanent Secretary, Department for Transport, Bernadette Kelly, Director General, Rail Executive, DfT, and Peter Wilkinson, Managing Director, Passenger Services, DfT, gave evidence.

              Q1 Chair: Good afternoon everyone, and welcome. We are here to discuss rail franchising and the Report from the National Audit Office. I am pleased to welcome our witnesses, all from the Department for Transport—here mob-handed today, Mr Rutnam. From my left to right, we have Peter Wilkinson, the managing director for passenger services; Philip Rutnam, the permanent secretary, who was here only a week ago—

              Philip Rutnam: Two weeks ago.

              Chair: Two weeks ago—and we have Bernadette Kelly, the director-general for the rail executive.

              It is worth reminding us all that the last time the Committee discussed rail franchising was in 2012, in the wake of the collapsed competition for the InterCity West Coast franchise, which it is fair to say was a fiasco. The Department has acknowledged a lot of problems there and the debacle has left it picking up the pieces ever since. You have now needed to award directly not just one, but 10 franchises without the benefit of competition, so there are some worries there. There have been early improvements to the franchising programme, but a concern for us is the dwindling market interest and the uncertainty around the delivery of major rail projects, including High Speed 2, and that has an impact on the franchising.

              I would like to ask you, Mr Rutnam, to highlight some of your concerns. Which issues and decisions are most worrying you in this now quite complex market, notwithstanding that there have been some improvements in how you are managing the programme, which we acknowledge and will get on to? What are the decisions coming up that will worry you about whether you will manage to keep this programme on track for passengers and for the taxpayer?

              Philip Rutnam: The franchising programme is now in a completely different place from where it was 2012 or, indeed, in the years before 2012. It is more robust, more resilient, better thought through, and better resourced within the Department, and the quality of the dialogue and of the commercial relationship between the Department and the market is also a great deal better.             

                            Now, there are significant execution challenges and things to be done in the franchising programme that are complex and will involve the careful management of risk. Many of them are mentioned in the NAO’s helpful Report. We need to make sure that we keep very actively engaged with the market to sustain the level of market interest. We need to ensure that we keep the terms of the commercial offer that we are putting to the market under review to ensure that it strikes the right balance between taxpayer, us acting on the behalf of the taxpayer and passenger, and the private sector, not only to sustain private sector interest, but to drive outcomes that really are in the long-term interests of passengers and taxpayers. There is a range of things to be done within the context of franchising, but I think the programme is in a hugely better place overall.

              As the Report also mentions, probably the single biggest issue is about ensuring that the relationship between the significant investment programmes happening in infrastructure and franchising itself is also cleverly managed. We actually have a reasonable track record from the perspective of franchising in terms of managing that relationship and it will continue to be a challenge. The Government and Network Rail are putting very large investments into the railways and they will continue. You probably saw the recent announcement of the re-plan of Network Rail’s CP5 programme, but we are also busy getting on with HS2, which will create a new dynamic. All these things will have an impact on franchising, but that is probably the single biggest issue if you wanted me to pick one out.

              Q2 Chair: What keeps you awake at night most? Is it that competition might dry up and you might have to do more direct awards, which would lead to worries about the value for money for the taxpayer? What is waking you up at 3 in the morning?

              Philip Rutnam: Fortunately, I am not generally kept awake by worries of that kind. Otherwise, there might be quite a lot of things to keep me awake. I would say again that I think we have a really good programme now that is well resourced in the Department. There are lots of things that we can continue to do better in that respect, but we also need to ensure that we keep a firm view of the bigger picture of the railway in the round—the infrastructure, the rolling stock and the franchise—and make sure that across the complexities of the industry, which is complex whatever structure you have for it, we drive towards long-term outcomes that are in the interests of passengers and taxpayers.

              Q3 Chair: We will talk a bit more about that big picture. Before I hand over to John Pugh, who is leading our questioning today, am I right that you have just appointed a new head of contract management?

              Philip Rutnam: Yes, earlier this year, I think.

              Q4 Chair: Earlier this year—forgive me. How full is that new contract management team?

              Philip Rutnam: It is a large and active team.

              Q5 Chair: So everyone has been recruited.

              Philip Rutnam: There are some vacancies and there are also some interim roles where we are seeking to reduce the number of interims and replace—

              Q6 Chair: Can you give us a rough idea of the number and how many of them are interim?

              Philip Rutnam: I will ask Mr Wilkinson to speak on the details.

              Peter Wilkinson: So this year, we will need a headcount of around 259 people to manage all the franchising.

              Chair: 259?

              Peter Wilkinson: That is not just contract management. It includes all the people required to manage franchise competitions.

              Q7 Chair: We are particularly interested in the management after the competition.

              Peter Wilkinson: For in-life, I think the complement of the contract management team is in the region of 40 to 50 people.

              Q8 Chair: 40 to 50. Okay. How many vacancies and interims are there?

              Peter Wilkinson: Our vacancy gap is running at 17%.

              Q9 Chair: 17%. How many of the remaining ones are interim?

              Peter Wilkinson: Sorry, can I correct that? Our vacancy gap is actually running at 9%.

              Q10 Chair: 9%. Okay. How many of the remaining are interim appointments?

              Peter Wilkinson: Of our total complement across my business—

              Chair: The 259 figure?

              Peter Wilkinson: Yes. It is 17%.

              Q11 Chair: Okay, so that’s where the 17% comes in. It would be helpful if we could know how many are interim in that 40 to 50 people, because the contract management bit seems to us quite an important area.

              Peter Wilkinson: We actually have very many more permanent civil servants in situ in the contract management piece. You would expect to see more interims in the competition arena, because that is where resourcing is obviously up and down according to the—

              Q12 Chair: It would be helpful to send us that figure if you have it.

              Peter Wilkinson: We can follow up on that.

              Q13 Chair: You have an agreement with the Treasury that you can increase the public sector pay cap. Have you had to do that so far in that arena?

              Peter Wilkinson: We have agreement for some flexibility—you are quite right—to apply some allowances to the civil service pay structure. We have used that in a number of instances to attract high-calibre individuals from the private sector, and we have been successful in doing so.

              Q14 Stephen Phillips: What does “a number of instances” mean? How many times?

              Peter Wilkinson: I can’t answer that question off the top of my head, but it is—

              Q15 Chair: Can you write to us about that as well, and tell us how much above the restraint you have had to go to attract the right people?

              Peter Wilkinson: Again, I will follow up in writing, but we are talking about 10% to 15% generally speaking.

              Q16 Chair: That is helpful to know. We may come back to that.

              Q17 John Pugh: This is not really a bad Report, in the sense that we are making some progress with the franchising. Mr Rutnam, you have been in the Department since 2012, and you will probably be aware that most rail firms—most TOCs as were—have for some time been complaining about the length of the franchises, the shortage of them, their intermittent character and so on. What is the optimum length of franchise that the Department is now aiming for?             

              Philip Rutnam: One of the things we did in the aftermath of the West Coast episode was to undertake a review. In fact, it was undertaken for us by Richard Brown, an eminent figure in the rail industry. He reviewed the policy framework and design of franchises, and we are still following very much the general framework that he set out at the beginning of 2013.

              Richard said there is no single answer; it depends on the nature of the railway in consideration, its characteristics, how much upgrade it will be subject to and so on. Broadly, though, he recommended that a typical franchise length should be in the order of seven to 10 years, and usually not less than five years, for a new competitively awarded franchise. There might be exceptional circumstances when it could go up to 15 years, but that was the typical length he talked about—seven to 10 years—and some good reasons for that were explained in his report.

              Q18 John Pugh: Without going into the report in great detail, would it be fair to say that the industry thought a longer franchise period would be better?

              Philip Rutnam: The industry has had mixed views. Part of it expressed views in the years before 2012 in favour of longer franchises; indeed, if you go back to the start of this millennium, 2000 and the period just after, policy shifted towards longer franchises—I am looking, for example, at the Chiltern Railways franchise. My sense is that the industry developed quite a strong consensus—not unanimous but quite strong—behind the recommendations in Richard Brown’s report.

              An important point that I might bring out is that one of the things that was established by the West Coast episode and, in truth, should have been thought through more fully is that risk in franchises does not rise in a linear fashion with time; it tends to rise exponentially with time. Unless you do something about this, the longer the franchise, if you get beyond the seven to 10-year point, the more you can start having significant levels of risk.

              Q19 John Pugh: I am sure the industry, having heard what he said, will send us its comments. Your job is to let out a number of franchises within a fixed period. What is the most you can cope with running at the same time? You clearly make an effort to stagger them, and clearly that is what you want.

              Philip Rutnam: We have a programme that includes in the next couple of years awarding a sum total of four franchises within an eight to 10-month period.

              Q20 John Pugh: That is copeable, is it?

              Philip Rutnam: We believe it is. We would not be planning on that premise unless we thought it was copeable with. We obviously built that into our plans for resourcing, preparing the advice we will need, the process and engaging the market. I would not want the programme to go much beyond that to six or eight or more, but we believe that four is certainly copeable with.

              Q21 John Pugh: What effect does it have? The Department’s ambition to get more new entrants to come in and bid is laudable, but looking through the companies,as analysed by the NAO, some of them seem to be the same company under different names; there are relatively few players in the field at the moment. In terms of new entrants, what have you seen?

              Philip Rutnam: The NAO Report gives a helpful table showing that nine or 10 companies are active in the market now.

              Q22 John Pugh: Are there any that weren’t active before you started this process?

              Philip Rutnam: We have had some new entry in the bids we have received, and we have an active approach to seeking to widen the market. Mr Wilkinson may wish to comment, but he has certainly put a great deal of effort into making sure that we do all we can to keep this a dynamic and fresh market, not one that goes down into an oligopoly.

              Q23 John Pugh: What would success look like? Would you expect, every three or four years, a new entrant?

              Peter Wilkinson: It is important to recognise just what we are talking about with franchises. Franchises are very large commercial businesses. They represent, to any corporation running one of these franchises, a very large single balance sheet risk. In the world today, there are only a fairly limited number of companies in the transport sector, or companies who specialise in that sector, who would be able to withstand that sort of balance sheet risk.

              Q24 John Pugh: So what you are really saying is that it is unrealistic to expect many new entrants.

              Peter Wilkinson: I do not think that we are seeking many new entrants. We have world-class companies in our market today. I would expect us to see one or two, two or three new entrants join this market in the next two or three years, yes.

              Q25 John Pugh: In order to sharpen up competition, you clearly use the device of threatening to run the railways yourself from time to time, because you are an operator of last resort. Is that right?

              Philip Rutnam: As the NAO Report mentions, in relation to the direct awards programme, where we have now successfully let 10 direct awards, we used a range of tools to make sure that we were driving the best possible value for taxpayers, and one of those, indeed, was the threat of ultimate resort to directly operated railways. I have to say that that was very much a last resort, rather than a first resort, but it is mentioned in the Report. That is one of the—I do not like using the word threat, but ultimately we are looking to use a range of tools to drive the best possible outcome.

              Q26 John Pugh: The question occurs that if you can use it as a threat presumably to drive the price of the franchise down, you must have done some modelling that shows you that a directly run railway is a remarkably efficient way of running a railway.

              Philip Rutnam: That question rather presumes the outcome to the modelling. What we did was use a range of techniques, including very close and careful attention to what we thought the costs of running the railway should be—it was a very complicated thing, so there are any number of different assumptions and a great deal of knowledge is required to arrive at that, but the sense of establishing a benchmark, so that we can assess on our own account the quality and cost-effectiveness of the bids being put to us by the supplier, was an absolutely integral part.

              The role that directly operated railways played in those negotiations was really to act as a credible back-stop. We were seeking to reach an agreement with the supplier, but if we could not reach that agreement there was a credible back-stop.

              I should say that directly operated railways was only one option there. Recently, you are probably aware that we concluded we were not able to reach an agreement with South West Trains, the owner of that franchise, for a direct award on that railway. That was earlier this year. We concluded that instead we should move to a full franchise competition in that case.

              Q27 John Pugh: When you say a credible direct operation, presumably you mean one lower than the bid you were receiving. Am I right in thinking that? Otherwise, it would not be much of a threat, would it, so say, “We can run it ourselves, but at greater expense”?

              Philip Rutnam: There is a range of tools that we were using to drive the best possible outcome from the negotiation we were having.

              Q28 Stephen Phillips: What were the outcomes?

              Philip Rutnam: Mr Wilkinson may want to comment, because he was overseeing this very closely. In some cases—I have given the example of South West Trains—there was the possibility, if we did some other things, of moving to a full franchise competition. So that is a credible threat. Having a very clear understanding ourselves of what we thought the costs would be, so that we had our own comparator.

              Q29 Stephen Phillips: That is direct operation again, so that is the same thing.

              Philip Rutnam: No. Perhaps Mr Wilkinson might want to comment. It is actually a rather different point.

              Peter Wilkinson: We develop a very comprehensive baseline of what it costs to run the railway today, and then we add into that baseline what we know we want to achieve through specifications by way of improvement on that railway, plus contemporary macroeconomic information from the ONS and OBR. Effectively, that gives us a robust baseline against which we would test and examine inbound bids from the private sector. That gives us a very clear ability to assess whether the bids we are receiving are value for money.

              Q30 John Pugh: Can I go into another general area? I want to talk a little bit about the Northern franchise, but first there is an acronym that is new to me: SOSRAs, which I think are Secretary of State’s risk assumptions. Those clearly differ from contract to contract. Can you tell us what they might look like in different contracts? What risk assumptions does the Secretary of State factor into any bid price?

              Philip Rutnam: I could comment, but Peter is probably best placed to do so.

              Peter Wilkinson: One of the key recommendations Richard Brown made in his very credible report was that risk is best placed where the management of that risk is best undertaken. There are some risks that you would not expect the private sector to be able to take, because they are unable to control those risks.

              Q31 John Pugh: Could you exemplify them in some way?

              Peter Wilkinson: For example, if the Office of Rail Regulation, which is a regulator independent of the Government and the Departments’ activities, were to decide to award significant new capacity on the route to an independent open access operator, that would present a risk to a franchise, which the franchise owner, and the bidder therefore, could not manage. There are certain situations in which a major change in infrastructure that is not contemplated would provide a level of risk that the franchise operator could not manage.

              Q32 John Pugh: So these would differ from contract to contract?

              Peter Wilkinson: Yes.

              Q33 John Pugh: As a matter of interest, which contract currently to be let contains the biggest number of uncertainties or assumptions?

              Chair: Perhaps you could explain them to us as well.

              Philip Rutnam: I couldn’t answer that question. All of these contracts have uncertainties and risks. These are commercial transactions: there is risk in the very heart of these transactions.

              Q34 Chair: One of the big risks we have touched on already relates to infrastructure changes. That is one of the reasons for the direct awards. It is causing some difficulty. I don’t know which of you is going to answer this, but what is the Department doing to best calculate the risks to the operator of those infrastructure changes and the slippage in timetable for many of them?

              Bernadette Kelly: I am happy to comment on that. The first line of defence, in a sense, is the programme, which the NAO Report itself has highlighted, for managing the timetable of franchise competitions and managing the use of direct awards in such a way as to ensure that, when competitions are run, they are as well aligned as they can be with—

              Q35 Chair: That sounds great, but we have had the Hendy report. That is the ideal, so what is—

              Bernadette Kelly: Indeed, that is the ideal. Clearly, we now have the Hendy report. As a consequence of that, we now have a re-plan of the CP5 enhancements programme. That should, in itself, mitigate quite a lot of the near-term uncertainty that has existed, while that report has been under way, for competitions and potential bidders in those competitions. We now have a clearly defined enhancements plan going forward, with a more robust set of underpinning assumptions about deliverability.

              Q36 Chair: So will you be issuing some franchises before the improvements have happened, which might finish before electrification, for instance, on TransPennine? Rather than doing direct awards, will you actually be doing competitions to fit with your staggered competition model?

              Bernadette Kelly: We will still need to take a judgment—Mr Wilkinson will still need to take a judgment—case by case about what is the best way forward for each of the competitions now envisaged. What I would say is that we have also sought very clearly, in the priorities that have been identified in response to Sir Peter Hendy’s report, to ensure that we are, wherever possible—and we are in fact—prioritising infrastructure investment which we know is likely to be critical in terms of a franchise interdependency.

              Q37 Chair: The last time Mr Rutnam was in front of us, we were talking about Network Rail and Great Western electrification. Does the Hendy report mean that you can now run a competition for Great Western?

              Peter Wilkinson: We implemented a direct award with the current incumbent on Great Western. That is one of the longer direct awards we offered up. That was by design, to give us the time to properly understand the shape and design of the Great Western electrification programme. I believe that the time and duration of that direct award is still appropriate. It is entirely within our means to be able to design that programme within the life of this direct award. I would expect to be competing the Great Western franchise at the end of this direct award.

              Q38 Chair: Can you remind us of the timescale?

              Peter Wilkinson: It is a three-and-a-half-year direct award, with the possibility of a one-year extension.

              Q39 John Pugh: The assumption might be that the franchise is going well at the moment because you have gone for the low-hanging fruit first, and that some of the challenges ahead are going to be greater than the ones you have currently met. Can I talk a little bit about the Northern franchise—a franchise I know particularly well? At one stage, it was basically a care and maintenance or bucket franchise; if anybody would take it, they were prepared to give it to them. In terms of your plans for that, am I right in assuming that the franchise exercise is on an infrastructure-agnostic basis—in other words, you are not assuming that electrification schemes will be in place at any one point during the franchise?

              Bernadette Kelly: Mr Wilkinson can comment on exactly what assumptions are built into those franchisee competitions, which are actually very well developed now and nearing their final stages. What we have done in response to Sir Peter Hendy’s report is said very clearly that we will now proceed with the work on the TransPennine Express electrification and that the development work will continue.

              Q40 John Pugh: I know you are going to do that, but if I am bidding for the franchise now and do not actually know when I will need electric trains, and I have to go to a TOC and get rail stock and things like that, I cannot price it very adequately without knowing precisely what the timescale is for the infrastructure. When you talk to the franchisors, are you basically saying, “Work on the assumption that electrification will occur by point B in time,” or, “Ignore all that”?

              Bernadette Kelly: No, we are saying, “Work on the assumption now that the timescales for electrification will be the timescales that the Government has set out in responding to Sir Peter Hendy’s re-plan and, indeed, in the Government’s announcement on the unpausing of the TPE and Midland mainline earlier in the year.” We now have some clear timescales going forward for those programmes, and we would expect and encourage bidders in any competition to work on those assumptions.

              Philip Rutnam: Peter can perhaps comment on the specific assumptions underpinning the Northern and TPE franchises.

              Peter Wilkinson: The ITTs for the Northern and TransPennine franchises are a matter of public record. You can read for yourselves the assumptions in them, but essentially, what we gave the market to understand at the time we issued those ITTs was the programme of electrification as it was known at that time, and we asked bidders to bid on that basis. We can then—this is important to understand—adjust in franchise life for the movement of those infrastructure programmes. We would expect, in life, to adjust the rolling stock and operation of those franchises commensurate with any change in the delivery of the infrastructure during life.

              Q41 John Pugh: But it is rather like PFI. If you can come back and have a further conversation down the line—a contract that might at first sight look very effective, value for money and so on might turn out not to be if the franchisor that holds the franchise says, “Electrification is now in place but I need to replace all the diesel stock I’ve got and get in electrified trains, and the market price has gone to x.”

              Peter Wilkinson: We have a very mature bidding market that absolutely understands—this is the value of a mature bidding market—the infrastructure environment and context we are working in. The good thing about having a world in which the public sector specifies the outcomes it is trying to buy and the private sector sets out how it will deliver those for you is that the private sector is given the freedom to innovate. There is a lot you can do with your rolling stock and rolling stock strategies to build in the flexibility that allows you to adapt to those changes in a way that is value for money. We should not focus unduly on the infrastructure. An enormous amount of value can be derived from innovation for passengers through competition, outwith changes to the infrastructure.

              Sir Amyas Morse: I may be wrong about this, but I thought that in some franchises you actually specify the rolling stock that you expect the franchisors to use. Is that not true?

              Peter Wilkinson: That is increasingly less our ambition.

              Sir Amyas Morse: So it has been the practice, but you are now changing it.

              Peter Wilkinson: What we are seeking now is that for the market, we specify the outcome we are trying to buy, which is essentially a level of capacity for the peak and the off-peak.

              Sir Amyas Morse: I can see that that is desirable; I am just trying to check. I presume that if an electrification is planned to happen in the middle of a franchise period, you are going to be stuck with specifying a hybrid or something of that sort, aren’t you?

              Peter Wilkinson: We do not specify the technology of the train. Basically, we tell the market everything we know about the infrastructure, the changes that are intended to that infrastructure, the programme of work associated with that infrastructure and the timelines; and we ask the market, at a point in time, to bid on the premise of that information. That is what we do; it is for them to develop their rolling stock strategies.

              Philip Rutnam: There will be very strong economic incentives for them to adopt electric rolling stock, for example, because it has lower operating costs and higher performance, generally.

              Q42 Chair: Well, if they know when electrification is going to happen.

              You now have three different models: the full competition, the in-franchise change and the direct award. On the in-franchise change, do you know what the cost is at the beginning, or how do you work out the cost? I ask because there is potentially a heavy load on the taxpayer at that point. You have someone in position and they hold the whip hand, or how do you make sure that the taxpayer gets a fair crack of the whip?

              Peter Wilkinson: That is a very important question. I hope they don’t hold the whip hand—

              Q43 Chair: It feels like it from our side. Persuade us how that is not the case.

              Peter Wilkinson: I hope they don’t hold the whip hand. I think we are an intelligent enough buyer to be able to mitigate that, but it is a very important question, because there are a number of franchises coming up. With the massive scale of investment by this Government that is going into the infrastructure, very few parts of our railway system are not being touched by significant infrastructure change. Therefore, managing change during franchise life is going to become a more regular way of doing things. What we have to do, therefore, is this. In the same way as we do with direct awards and with franchise competitions, we have to baseline our expectations of how the costs will change, so that we ensure that the market, in responding to those changes, is giving us a value proposition.

              Rebecca Sheeran: Going back to the point about rolling stock, Peter, I think it might be helpful to clarify for the Committee the Department’s plans in terms of specifying the use of the IEP trains for East Coast and Great Western and, indeed, the Siemens trains for TSGN.

              Sir Amyas Morse: In fact, you are specifying quite a lot.

              Philip Rutnam: Some.

              Sir Amyas Morse: Quite a lot.

              Philip Rutnam: Some. It is a mixed picture and it is a complicated industry. I think a mixed picture is likely to be the approach that is going to drive the best outcomes, because there is such a range of outputs that we need from this industry. In some cases, Government taking decisions about investment in trains brings better outcomes, and we have discussed that before in relation to very big programmes, in which case of course we specify that the trains—

              Chair: I think we have got the general picture about the complexity.

              Sir Amyas Morse: I am not really objecting to that. I just think it was verging on being a little bit misleading to just say, “Well, we really don’t do that.” In fact, you are doing a lot of it.

              Q44 Chair: Perhaps, Mr Wilkinson, you can clarify this. Were you saying that in the future you are hoping to have the new model that you just described about allowing the private contractor to decide and that you are still wedded to the old model for some of the existing competitions that are—

              Peter Wilkinson: To be really clear about this, the Government bought—I mean it procured—IEP trains and the Siemens trains. That is not our practice today. Our practice today is to procure trains through the franchising process and to let the private sector—

              Q45 Chair: So from now on, more or less.

              Peter Wilkinson: Even given that, clearly we specify to an extent the use of the IEP train, but the IEP train itself—its traction, its power, can be varied according to the traction in place at the time. For example, the first phase of IEP trains being delivered are bi-mode trains by design, so we can use those flexibly over the network.

              Sir Amyas Morse: I just want to make quite sure we are clear about this. As you rightly say, the first phase of delivery of these trains has not even happened yet; it is about to happen, and they are likely to have a useful life of about 30 years, so it will be a mixed economy for a very long time to come in reality, in terms of rolling stock that you have specified that has to be moved around the system. That is the picture.

              Philip Rutnam: I think it will be a mixed economy. Peter is absolutely right that our whole policy orientation is towards allowing the market to make decisions about investment in rolling stock, but I would not preclude circumstances arising in which we decide that the taxpayer or Government needs to play a bigger role. Who knows what will happen? We have decisions in relation to HS2 coming up, for example. There will be a large need for rolling stock investment in that case. I think the mixed economy is an analogy and our general approach is to try to get the greatest possible value for taxpayers and passengers from rolling stock.

              Chair: We will continue to probe. That is the bit we are interested in. It sounds like it is a very flexible model and we need to pin down the taxpayers’ interest. I am going to ask John Pugh to help us in that.

              Q46 John Pugh: I am looking for clarity. I go back to the Northern franchise, which is the one I know best, so please bear with me. You are basically telling me that, in terms of letting that franchise, you are going to specify to the people bidding that there will be certain network changes over a period time, that is, electrification as planned, and that they need to bid on that basis.

              I think you have also said that you are going to be agnostic on rolling stock. It is their job to find a way of dealing with the anticipated series of network changes: electrification and so on. Is that correct?

              Philip Rutnam: Shall I have a go, and then Mr Wilkinson can add or subtract, if I do not get it quite right?

              John Pugh: Yes, please.

              Philip Rutnam: I believe in the Northern and TransPennine franchises we specified, as base assumptions, that the north-west electrification programme, which comprises five phases, proceeds to certain dates provided by Network Rail. That programme, by the way, remains following the Hendy re-plan. The work is midway through phase 3, with phases 1 and 2 completed. We also specified on those franchises—and this point particularly affects TransPennine rather than Northern—that bidders should not make any assumption about electrification of the TransPennine route from Stalybridge to Leeds.

              Because of the uncertainty that we recognised existed about that particularly difficult bit of franchising, we asked them not to assume electrification of that. We said we would deal with that electrification when it happened as an in-life change. So, it is a mix of some very clear assumptions across the board for the purposes of putting a bid together, and an expectation that, in relation to one particularly uncertain bit of infrastructure development, we would deal with that in-life.

              Q47 John Pugh: You are basically leaving it to the market to decide how they deal with that proposition.

              Philip Rutnam: In relation to the rolling stock and the service pattern, we want the best possible bids from them. In relation to rolling stock, we again set some parameters, which were intended to provide a minimum level of stretch in the bids. On the Northern franchise, for example, we specified a minimum of 120 new-build vehicles to be brought into use in the franchise, and we specified a requirement that all of the very unpopular Pacers should be withdrawn from use by 2020. But then it is up to the bidders. So those are some prescriptive specifications from us.

              Q48 John Pugh: You have anticipated me. My next question was going to be: what would you do if, due to the delay in electrification, they kept the Pacers going as a reasonably viable option, given that there are lots of them and they have a utility to that bigger network? That is in the franchise; there is a rolling-stock specification?

              Philip Rutnam: I do not think that is significant dependency and the Government are very clear that they expect the Pacers to be withdrawn from use by 2020.

              Q49 Chair: Is that because of this new focus on passenger experience that you are building into the piece? Because they are unpopular.

              Philip Rutnam: The Pacers are indeed unpopular. There was the option of retaining them in use but they would need some significant work done on them.

              Q50 Chair: Which was the main driver for getting rid of the Pacers? Was it passenger experience?

              Philip Rutnam: I think ultimately the main driver was passenger experience. In truth, overarching that was Ministers’ view that they were quite old; but even more than being old they do not fit and the ride quality is poor. Ministers’ view was that the continued use of those vehicles was not compatible with their overall vision for the northern powerhouse, regeneration in the north and connectivity in the north,

              Q51 John Pugh: And replacement of stock is independent of any cascade effect from elsewhere, so it cannot be derailed by failure to decommission stock elsewhere.

              Philip Rutnam: I do not want to say that nothing can ever happen, but the Government are very clear that they expect the Pacers to be withdrawn by 2020. Bids have been invited on that basis. We are at the latter stages of the competition, so I hope you are not going to ask me to comment any further on the competitions themselves.

              Q52 John Pugh: My last question is on things that can derail things. What is the problem with Euston station and how is that going to impact on the whole process?

              Philip Rutnam: What problem with Euston station? [Interruption.] High Speed 2. Perhaps Mr Wilkinson would like to comment on the interface with High Speed 2.

              Peter Wilkinson: The Department has very mature processes internally for marrying up a number of programmes and the interfaces between those. We have a number of very significant programmes running at the moment that have complex interfaces we have to manage. HS2 is one of those. Clearly HS2 will require some significant re-engineering of the capacity at Euston station to permit high-speed trains to access that facility. During the construction period, that will inevitably bring some perturbation to the west coast main line’s capacity into that station. That is something that we have to plan for and manage in maintaining the in-situ operations of the Virgin West Coast and West Midlands franchises.

              Q53 David Mowat: I am interested in how the whole market works. I think you said earlier that there were nine or 10 players and you have got about 15 franchises. Have all of those nine players you currently see in the market won at least one franchise somewhere so far? It is yes or no, really.

              Peter Wilkinson: No, they have not all won.

              Q54 David Mowat: If you award a franchise for seven or 10 years, someone wins that and then they are the incumbent for the next refranchising process, how do you attract other people to bid against them? The knowledge from being an incumbent must be high. Does the incumbent think that good performance will enable them to carry on, or is it very clear that there will be a re-letting process?

              Peter Wilkinson: No, it is absolutely clear that there is a re-letting process.

              Q55 David Mowat: How do you make sure it is a proper process? Just as a question of fact, whenever you have done this re-letting, what percentage of times has the incumbent won versus somebody new?

              Peter Wilkinson: I will have to come back to you on the specific answer to that question.

              Q56 David Mowat: Off the cuff, would you say the incumbents are dominant?

              Peter Wilkinson: I do not think they are dominant. The important thing here is that there is going to be a competition. That is the Government’s policy: we compete these services in the market—

              Q57 David Mowat: Yes, but in the competition the level of knowledge is so different. If I were to bid it could cost me £1 million or more—I do not know how much it costs, but I am sure it costs quite a lot. So you can see the dialogue that some of them might have. In fact, in some cases they may just be bidding to keep you happy by giving you a competition, knowing that there may be another one somewhere else.

              Peter Wilkinson: One of the most important premises in the modern franchising process is the principle of a level playing field. That is something we work extremely hard to provide for. So essentially we put obligations on the incumbent to share with the Department absolutely everything about that franchise.

              Q58 David Mowat: I understand. So judge and jury of the level playing field principle that you say is so important would be the number of times that a non-incumbent has won or what their percentage win is. Perhaps you could write to us on that; I would be very interested in that statistic, because that is the acid test, isn’t it?

              Peter Wilkinson: It is not the acid test. The level playing field is absolutely a fundamental principle of modern franchising. The acid test of whether you win the franchise is whether you respond to our price and quality specification—

              Q59 David Mowat: If the incumbent wins 80% of the time—this is hypothetical; I do not know if it is true—and two non-incumbents win 10% of the time each, that raises questions about the value of incumbency and the extent to which you have been able to create a level playing field, doesn’t it?

              Peter Wilkinson: I am not sure you could draw quite that correlation.

              Q60 David Mowat: Why not?

              Peter Wilkinson: Because effectively a new franchise is a reset of that business. Our specifications at the time we compete that franchise will be providing for quite a different business from the one that existed previously. So we would be expecting to see a lot more—we do not want to manage stasis; we do not want ossification of the railways, so essentially each time we compete these businesses we put sufficient into these competitions to create a marked difference in the way that business works.

              Q61 David Mowat: That is great. I understand that and I hear what you are saying. All I am saying is that if you have a process that has three players in it and 80% of the time the incumbent wins, that raises an issue as to how successful you are in doing it. That is all I am saying, and I would expect you to know the answer to that. That should be something you are watching out for.

              Peter Wilkinson: We are very early into this. So far we have completed only three competitions. I think this is something that we would expect to keep under observation and watch for. It is absolutely—

              Q62 David Mowat: But you agree with my point that if you were finding that 80% of franchises were won by incumbents, that would raise a question, wouldn’t it?

              Peter Wilkinson: It would raise a question.

              Q63 Chair: I just want to ask a couple of questions. I want to be clear whether TUPE applies for a new franchisee at the start.  If there was no particular incentive to win—well, there is an incentive to win—the staff would not all lose their jobs overnight, would they?

              Peter Wilkinson: No, TUPE applies in all regards.

              Q64 Chair: You said earlier—it might have been Mr Rutnam, or it might have been you, Mr Wilkinson—that you are not seeking many more entrants into the market, but paragraph 3.22 on page 30 of the Report sort of fits in with what David Mowat was saying. The NAO has looked at this and says that a lot of the bidders are a bit put off bidding because of the complexity and cost of the process. That paragraph lays out the problems for bidders. Are you worried about losing any of these competitors in the market? You may not want to expand the pool you have, but it may shrink further because of these concerns, so how you are addressing them?

              Peter Wilkinson: Inevitably, in any market, you see new entrants, and you see existing entrants leaving the market. The role of the Department is to do its level best to manage that market. It is not a case of our not wanting to see lots of new entrants to the market; it is a question that these are large commercial concerns. By design and by nature—

              Q65 Chair: But the NAO has looked at this, and this is your work saying that these are challenges to maintaining the current number of bidders. If that reduces, the level of competition reduces and there are all these other different ways of awarding franchises such as direct awards, which are an imperfect but temporary solution. There are changes and variations within a franchise. What would the residual model be if the number of bidders reduced so that the competition was no longer effective?

              Philip Rutnam: To be honest, that it a hypothetical question.

              Chair: But you have done the work to guard against it or to highlight the concerns so you must be thinking about it.

              Philip Rutnam: We are very clear that it is part of our job as the Department to maintain a competitive and dynamic market. We think we will get the best outcomes for passengers and taxpayers if we achieve that. In the relatively short period that the new programme has been running, we have had some new entry, and I would certainly like more new entry. We will keep encouraging parties to look at the market. They often think about entering perhaps in partnership, rather than directly and wholly on their own account. We will certainly keep a close focus on that. We are also doing things that are mentioned in the Report to try to ensure that the costs of entry are kept low. For example, lately we have made the pre-qualification process simpler and easier so that people do not have to pre-qualify for each—

              Q66 Stephen Phillips: Those are the direct costs. One of the things that Mr Wilkinson said earlier was that we have a mature bidding market. That carries with it the implication that these are nine or 10 companies that know the game and how to play it. You may have reduced the direct costs but, in order to achieve what you have just described as the Department’s desire for a dynamic market, what specific steps is the Department taking?

              Philip Rutnam: You are quite right that the market is mature. There are always risks in a mature market. The risk is that the level of competition—

              Q67 Stephen Phillips: There is a huge entry barrier for new entrants to the market, irrespective of the cost that the Department imposes, because it has to recruit the right people, get up to speed and so on. I return to my question: what is the Department doing to ensure that there is a dynamic market for franchises?

              Philip Rutnam: The things that I would point to are that we look at the scope for making some of the franchises smaller, for example—

              Q68 Stephen Phillips: Splitting them even further?

              Philip Rutnam: They are very large businesses on the whole. There are 15 franchises, and a bit over £9 billion a year in passenger revenue contracts that run for seven to 10 years. Those are very large businesses.

              Q69 Stephen Phillips: So smaller franchises is the first thing.

              Philip Rutnam: That is one thing that we look at. There are obviously a number of other considerations there. Reducing the direct cost of entry, as I have mentioned—

              Stephen Phillips: We have dealt with that but that is not the—

              Philip Rutnam: It is only part of the picture, but it is part of the picture. Third is an active approach in talking internationally to parties that have not yet entered the UK rail market.

              Q70 Stephen Phillips: Is that rail operators in other countries?

              Philip Rutnam: Potentially worldwide, yes. We have had some success in bringing entries. For example, MTR, which is an operator based in Hong Kong, is present in the UK rail market, as is shown in the NAO Report. Also, we are keeping under review the commercial construct, as I said earlier, to try to ensure that it offers a sufficiently attractive balance of risk and reward while keeping our focus very much on ultimate benefits.

              David Mowat: Can I just come back on that?

              Q71 Stephen Phillips: Forgive me, David; may I just finish this point? May I take you to the second of those: new international operators entering the UK market? How many of those has the Department spoken to in the last two years?

              Philip Rutnam: I don’t think we want to go into particular details on whom, but in terms of numbers, Peter?

              Peter Wilkinson: I can confirm that we have spoken to four different international operators and have maintained a dialogue with them.

              Q72 Stephen Phillips: How does that dialogue take place? Do you set up a meeting with them at their head office in some foreign country? How does it work?

              Peter Wilkinson: No, we invite them to come and see us. We operate a very open dialogue with our market. We see those companies seeking to enter the market in the same way we see those companies that are already in the market, and we are very open with them about the franchising process. We publish our franchising process. One of the things we have done that was not present before the west coast competition collapsed was absolutely to publish our franchising process to remove the mystique around it—to demystify it.

              Q73 Stephen Phillips: You referred earlier, Mr Wilkinson, to an expectation that there would be two or three new entrants to the market in the next few years. Are those two or three from the four that you have spoken to over the last two years?

              Peter Wilkinson: Yes.

              Q74 David Mowat: So we have these nine people in the market chasing, to some degree or other, the 15 or so franchises that you have. These are open book contracts, aren’t they?

              Peter Wilkinson: Yes.

              Q75 David Mowat: Of your 15 ongoing franchises, do you know which one is currently the most profitable for the incumbent? If it is commercial, don’t tell us, but could you tell us whether you know it or not?

              Peter Wilkinson: I am not going to discuss the margins of our private sector partners—

              David Mowat: But do you know the answer?

              Peter Wilkinson: I do know the answer. We know the margins they are earning and we have complete transparency and openness—             

              Q76 David Mowat: Because one way of managing this process—you said “margin”, but I would use the term “return on capital employed”—is just to manage the number. You put your constraints in and all the rest of it, and you manage to what you think is an acceptable return for them to make, and agree that with them. That enables you then to run contracts with all sorts of changes in them because you just agree that that is the change, but that is the return that they are expected to be able to get, and you just have a deal doing that. Is that how you do it?

              Peter Wilkinson: That is one model. It is not how we do it. We are sighted on the margins of our partners in the industry, but it is not actually their profit margin that we are buying. What we buy in franchising is effectively, first and foremost, benefit for passengers—the qualities that we would expect to see on offer for passengers—and secondly, the net cost difference. What we are always trying to do is to reduce the burden of franchises on the taxpayer, either by pushing up the premium return, or by reducing the subsidy that goes into—

              David Mowat: Yes, but the result of that—             

              Q77 John Pugh: Could you give us an idea of the range of profits made by individual firms? You don’t need to tell us individual firms; just tell us how they differ.  Do they differ markedly?

              Philip Rutnam: I think you are taking us down a very tempting route, but one of our jobs is to maintain the market’s confidence in the process that we run. To be honest, if we start getting into questions on the range, there will be speculation about who is at the top end of the range and who is at the bottom end.

              Q78 Chair: The point is that passengers’ fares take a lot of the pressure. That is certainly what our constituents feel.

              Philip Rutnam: It doesn’t actually quite work like that, but we can discuss fares if you like.

              Q79 David Mowat: It is quite fair to make the point that you have just made, actually, but although each of the franchises may be more attractive than others and there will be more capacity, I would not expect, over time, for their return to be different, because if the market was working and it was a perfect market, people would understand that and they would bid with a view of that return. What you would expect in a market, if it is all working, is for all these things to converge to a fair return.

              Peter Wilkinson: It is important, in the condition of our market, that our partners out there are earning a fair return for the investment and risk that they are taking. I am quite happy to tell the Committee that since privatisation, the general margins being earned have not changed dramatically. If anything, they have come down, so what that says is that we continue to maintain a reasonable pressure on the market to operate in a fair and sensible way. Indeed, with all our contracts, we have margin shares, so if margins go over certain thresholds, we absolutely see that being returned to the Government.

              Q80 David Mowat: And that is on the upside and the downside.

              Peter Wilkinson: It is on the upside.

              Q81 David Mowat: I just make the point again that if the market as you have described it was a perfect market, all these returns would be converging into something that was an acceptable amount. Do they ever come back after the start of the deal to say, “We expected a return of X% and it is actually only 70% of X%.  It is not our fault, so can we have a discussion about that?” Is that an acceptable dialogue to have?

              Peter Wilkinson: We have a wide range of commercial discussions with our partners in the market, but I don’t think I can go into that.

              Q82 David Mowat: Okay. Just one final question. It goes back to my earlier thing about how difficult it might be to dislodge an incumbent. You have a bidding process. Presumably you need three people, say, to suggest that the process is reasonable. Do you ever get any evidence of some of your eight or nine participants in this market bidding to do you a favour? It would not be so unusual. They would just say, “We don’t expect to win, but we will put a bid in.”

              Peter Wilkinson: No. I have no evidence of that at all.

              Philip Rutnam: Going back to the earlier conversation, it is a sizable undertaking for them.

              Q83 David Mowat: It depends how long they spend on the bid.

              Philip Rutnam: Well, the bids that we have received have been of a high quality. It is a sizable undertaking both in terms of direct costs and also senior management time and energy.

              Q84 Chair: Okay. Earlier you talked about breaking up the franchises into smaller parts, but the Thameslink, Southern and Great Northern one has merged into a very big franchise. Why?

              Philip Rutnam: Peter can speak to the detail, but this was carefully considered. We put a lot of time and effort into thinking about what approach we should take to this franchise. It is a very large franchise, as you say. Something like 20% of passenger revenue is in that franchise. The critical reason is that the whole of that group of services north and south of the river will be affected by the Thameslink programme, which is in the midst of construction right now. It will ultimately provide a district line service with 24 trains per hour north-south through London, complementing Crossrail east-west, and that will require a reconfiguration of routes, service patterns, frequencies and rolling stock, north and south of the river, across not every one of those services, but a large proportion of them. That was the heart of the reason, and that involved bringing together three different predecessor franchises.

              Q85 Chair: So far, what we have been hearing is that it is complicated. We have different types of franchise because of the approach in trying to get to this new modern system. Sometimes we let very big franchises, for whatever reason, but we are now looking at doing smaller franchises. We have been specifying the trains, but now we will not specify them so much. It sounds like a bit of indecision in the Department. After reading the NAO Report, we were quite positive about some of the plans for the management of contracts, yet we are seeing all these differences. Is it that you simply cannot make your mind up?

              Philip Rutnam: No, I really do not accept that. What it reflects is the complexity of the markets we are dealing with, and the complexity and range of different outcomes that we are seeking for passengers across a very large and complex geography. There is a world of difference between the commuter services covered by the Thameslink, Southern and Great Northern franchise and the high-speed intercity services of East Coast and many other types of service. So we have the service variety, the infrastructure complexity, and then—this would be my interpretation and I believe it very strongly—you have a smart purchaser acting on behalf of passengers and taxpayers to try to get the best deal and using a range of different tools as appropriate.  To be honest, we are not afraid of intervention where we think intervention, such as specifying a minimum of 120 new trains, is going to drive value, or it may be that we think standing back is going to drive value.

              Q86 Chair: I acknowledged at the beginning that we saw some improvements, which we recognise. You may know that this Committee is very keen on smart clients. We are also keen on smart contractor relationships. Maybe I can ask Mr Wilkinson: you talk about this mature model of companies bidding for these contracts, but how much is it a real partnership, especially if you are using a model where you have to change it part way through? Are you expecting them to have dialogue with you about how to make sure the passengers are getting a decent service and the taxpayers are getting a fair deal as well, rather than just you having to be smart kicking them? How much do you rely on them to tell you what the problems and issues are, and how is that working?

              Peter Wilkinson: My preferred style is not to kick anybody.

              Chair: Forgive us, we get a little impatient in this Committee and sometimes we use that language. If you could speak up, the acoustics in this room are very bad.

              Peter Wilkinson: I apologise. My preferred style is not to kick anybody; it is to build constructive long-term relationships. For the franchising market to work it has to be sustainable over a very long period of time. For a sustainable market you require a level of conduct and relationship in the market which is completely open and transparent. If there is not that transparency in the aims of Government and the way it wishes to procure those aims—if there is not transparency in the motives of the private sector—the two halves of that equation, the public sector and the private sector will find themselves bruising up against each other, and contracts will become very contested devices.

              Q87 Chair: We get the theory, so how do you make sure that it happens? You talk about the transparency—the reporting mechanisms you touched on earlier. They have to tell you stuff. That is one thing; but how do you make sure they tell you the stuff that might be going wrong—the things where they think they could save the taxpayer money? Do they do that? Are they that smart, and are you that smart—to make sure that they do it?

              Peter Wilkinson: They are that smart. We have a very good relationship with our market. The investors in our market invest a great deal of their time and energy actually thinking about how to innovate in franchise life. I would argue that, going back several years, franchising by design probably was not fostering that sort of environment. That is not true today. So, increasingly, if you were to compare, for example, the Anglia ITT against the kinds of ITTs that were being issued 10 years ago in franchising, you would find that what we are actually trying to buy are the outcomes that passengers tell us they want us to procure on their behalf. The way those outcomes are delivered is very much a matter for the private sector, and we will discuss in franchise life, if variables change in those inputs or the environment around that franchise, how to modify the way to achieve that outcome in a way that remains efficient for taxpayers but preserves and protects that outcome for passengers. That is less about contracts than it is about face-to-face relationships.

              Q88 Chair: I will ask Stephen Phillips to come in. Obviously we know about the legal challenge about what went wrong in 2012, with Virgin and so on, but have you had any legal challenges when you have tried to change? Are you discussing this with the lawyers or with the operational people in the companies when you want to change something?

              Peter Wilkinson: We discuss it with the operators.

              Q89 Stephen Phillips: Mr Wilkinson, just on this very specific point, I was going to ask you: you are essentially giving a picture of an agile contract management structure and of operating companies which are therefore permitted to innovate. If you look at the NAO Report and the summary on page 7, paragraph 9, the NAO recorded that “Transport owning groups told us, however, that the large number of committed obligations in franchise contracts results in a rigid approach to contract management which can be inefficient and limit innovation.” That is the picture from the other side, who are not, admittedly, giving evidence to us today; but they seem to have a very different view from the view which you are giving to this Committee. How do you explain that?

              Peter Wilkinson: I explain that because franchising has been going on in this country since 1995-96. Those owning groups will have experienced a wide range of procurement processes. They will be drawing on a wide body of experience of franchising. It is only very recently that we have begun to move in the direction of a much more outcomes-based procurement; and we are in the early stages of that.

              Q90 Q91 Stephen Phillips: If I had a pound for every time this Committee was told by various Departments that things are getting better, I would be a very rich man indeed. Basically you are saying things are different in relation to the last three franchise competitions and the ones that are going forward, from where they were in the past. Is that right?

              Peter Wilkinson: I am quite happy to give evidence to the Committee that, as you will see in the ITTs we have recently issued—in particular the last one, Anglia—and the ones that are now coming out, the direction that we have moved in very clearly is to tell the market a lot less about how to run its business and simply to lay before the market what it is that the Government is seeking to procure on behalf of passengers, having listened to the voice of passengers and stakeholders and voters.

              Q92 Stephen Phillips: Let me just give you the next sentence of what the transport owning groups were recorded as having told the NAO. “They also noted that the Department’s capability to manage franchise contracts has not yet noticeably improved.” That is the perception on the other side of the fence. What are you going to do to persuade them that you are getting better at contract management and that you are going to encourage innovation on their part?

              Peter Wilkinson: It is a fair reflection. I am not sitting here trying to pretend that we have changed the world overnight. We started the franchising programme again in 2013, and the first job that we had to do was rebuild trust in relation to the market and get a franchising programme back on its feet again. That was the first job, along with creating a schedule that was sustainable, and we have achieved those things.

              The next job—the NAO has been clear on this, and I support its conclusion—is to grow our capability in the area of in-life contract management and to improve how those relationships are managed during the term of the franchise. The reason for doing that is not some ethereal motive about mature contract management; it is because we procure benefits for passengers, and you do not just do that once, at the point of a competition. You are continuously trying to buy benefit for passengers and taxpayers through the life of a franchise, and that requires a commercial ability in-life to be able to negotiate change in response to the feedback you are getting from customers—real fare payers—about the services they are experiencing.

              Q93 Stephen Phillips: How much scope is there within these contracts for the imposition by the Department of change during the life of the franchise?

              Peter Wilkinson: That is something we have put under review—

              Stephen Phillips: That was going to be my next question.

              Peter Wilkinson: I would argue that in the past our contracts have been overly rigid. That is now changing. We have put our entire franchising agreement into a review that we are undertaking with the industry to address the concerns they have raised and to lay before them the contract in all its glory. That will enable them to show us the areas in which they feel rigidity is preventing them from innovating in franchise life, and that is the process we are going through now.

              Q94 Stephen Phillips: Is there essentially a standard contract that is imposed on all franchisees at present?

              Peter Wilkinson: Yes, there is a standard form of contract.

              Q95 Stephen Phillips: Right. How much latitude does it permit the Department to intervene in the life of the franchise to ensure innovation and an improvement in passenger services?

              Peter Wilkinson: That is a very fair question. There is more latitude than people might think. If you read the contract form, there is more latitude than you would think. Whether we have used that latitude in practice is another matter, and I would argue that we have not used it as much as we could have.

              Q96 Stephen Phillips: Is that laziness or incompetence?

              Peter Wilkinson: Neither. This is complicated stuff.

              Q97 Chair: Is it because you did not have that contract management capability?

              Peter Wilkinson: There are no small commercial or financial decisions in rail, so naturally the processes that you go through in evaluating and testing the value for money of any change or proposition is an undertaking.

              Q98 Chair: But you had no previous proper contract management. That is the change that we have welcomed. Will that be what makes the difference with the contract?

              Philip Rutnam: I think that is an overstatement. We had good or at least fair contract management, but we want the contract management to be outstanding. It is on a journey of development. It is some way behind the journey we are accomplishing on the award process, but it is the next priority.

              Q99 Chair: As a Committee, we want to see good smart contracting, but we are clear that ongoing contract management is critical. We are a little reassured by what we are hearing, but you are on a journey and it is going to get better tomorrow. We will have you back on this point.

                            Sir Amyas Morse: Just looking at how a person holding a franchise will react and what will produce positive or negative attitudes, you are relying on people trusting each other or developing transparency and trust, which will be driven not by sentiment, but by experience of the Department being consistent and not moving the goalposts halfway through contracts. Otherwise you will find people relying on their contract, because that is what any sensible businessperson will do. The question is, as you and the Department sit at the centre of this admittedly highly complex web that you have to run, whether you in a position to deliver consistency. I know you are talking about it, but the question is, can you deliver it? If you don’t—if you keep changing the terms in the middle of contracts—first, you will pay a lot of money and secondly, you are not going to develop the relationship with contractors that I accept you sincerely want to develop. Do you recognise that that is crucial and can I hear what you see as your role in it?

              Philip Rutnam: I completely recognise that it is crucial and all I can say is that not everything is ultimately within our control. Ultimately there are risks that are not in our control. You can have a very different political agenda, for example, but at the moment the Government have a very clear policy in this area, it has been set out for the rest of this Parliament, we in the Department are very committed to executing it in the way described in the NAO report, and we put a great deal of emphasis on taking a sensible, measured approach to building capability and planning succession within the Department, so that we can reinforce continuity through the way we build our own capability and put that into practice.

              Sir Amyas Morse: So you see the Department as the master integrator of the whole rail network, is that right? Is that your role?

              Philip Rutnam: I didn’t say that.

              Sir Amyas Morse: I said it; it was a question.

              Philip Rutnam: It is a rather different question.

              Sir Amyas Morse: In order to make this work, you really have to function pretty much like that, don’t you?

              Philip Rutnam: I did not say that and that is not the phrase I would use, but I think that responsibility for the overall strategy towards the development of the rail network rests with the Department. The Department has the principal levers in relation to policy, funding, the award of franchises and responsibility for the regulatory regime. I shall ask Ms Kelly, since she has overall responsibility within the Department for our interests in rail.

              Bernadette Kelly: It feels to me as if we are having a bit of a debate here about the tension, which I think is inevitable, between absolute consistency of approach and an approach which is flexible enough to manage the complexity and the dynamic nature of the rail system we have. I do not think there is a single, simple right answer to that.

              One area where we in the Department have a particular responsibility going forwards is in relation to how we ensure that the interfaces between infrastructure and franchising and between High Speed 2 development, infrastructure and franchising are managed. We are doing that. We already have in place a number of mechanisms—some pretty robust mechanisms—to manage those, I think, on High Speed 2. Now that we have a re-plan for infrastructure enhancements and investment, we will be putting in place much more robust governance, working both with the train operating companies and Mr Wilkinson and Network Rail to make sure that we are managing those interdependencies and taking really informed judgments about what is the appropriate use of in-year changes to contracts, et cetera, to manage the uncertainty that may still exist.

              Chair: I shall come back to the past experience, which is the bit we have not covered so far. Nigel Mills will come in on some of those points.

              Q100 Nigel Mills: I just want to understand how this all fits in to the cost-saving objective. I seem to remember that the taxpayer used to have a £4 billion net subsidy of the railway. What is that down to now?

              Philip Rutnam: It is a bit less than £4 billion. It ran significantly above that, on average, during the past decade. It peaked at nearly £8 billion in 2006-07 and there was a shoulder either side, but it was well over £5 billion for many of those years. The way it works now, essentially, is that the costs and revenues of the passenger businesses are broadly in balance. We pay a net subsidy to some of the businesses and we receive a premium from others, but broadly, it is in balance. That also includes a material contribution towards the costs of Network Rail for running the network.

              Our grant, which is about £3.5 billion at present, is overwhelmingly towards financing Network Rail’s capital programme It sort of makes sense if you can see a model where the operating costs of the railway are covered by the revenue to a significant extent and the Government’s principal role—not their only role—financially is towards enhancements. Of course, there will always be some services, including rural services and less well used services, that need an operating surplus.

              Q101 Nigel Mills: Presumably the spending review made a bit of a dent to your Department’s budget. I am just wondering, how much do you think you are going to have to try to squeeze out of the rail industry to meet that target?

              Philip Rutnam: You are right that, in relation to the current resource side of our budget, the Chancellor announced a significant reduction, of 37%. The capital side of our budget is, in fact, growing markedly. Our finances are rather unusual by Whitehall standards. The current, resource side of the budget is small, relative to capital, but it includes net income. The Department has a number of sources of income, of which rail revenue is one. One reason why that reduction is larger than for comparable Departments is because you project forward over the next several years. We expect continued growth in passenger volumes and in revenue sources in the railway.

              That is one reason why our resource budget can decline, so I would not see it in terms of squeezing additional revenue out of the railway. The Government have decided that fares should stay capped—RPI plus zero—so the sources of revenue that I do expect to see are overwhelmingly to do with growing numbers of passengers, growing efficiency in the railway, both in the Network Rail side and the train operating side. We have a railway which is a remarkable growth story. It grows each and every year by 4% to 5% in volume.

              Q102 Nigel Mills: That is what I was trying to get to. In coming direct towards some franchising, you are not going to be under a great deal of pressure to up the premium the bidders pay or reduce the subsidy you pay them, because you need to fix a hole that was created last week. It would just be a market test on what volume does.

              Philip Rutnam: We will always be setting ourselves challenging targets for the outcome that we want from a competition. The points Peter made about in-life management are very important too, but clearly the competitions are a very important opportunity to get the best from the market, in terms of outcomes for passengers and financially for the taxpayer.

              I set the team inside the Department challenging targets for what we should be getting in these competitions. We will then see whether the bids align with that, but there is not a change in strategy that comes out of the spending review in any sense; rather, the spending review in this respect is a sign of the successful performance on the whole—far from perfect—of our railway.

              Q103 Nigel Mills: So would one way to get numbers of passengers up on the railway probably be to have some competition on the line? But then that has a bit of a down impact on how much a franchise is going to pay for the right to run what is no longer a monopoly. Where are you on that? Are you still keen on competition on the big lines or are you drifting away from that, thinking it is just a bit too hard?

              Philip Rutnam: You are right there is a tension there. Perhaps Miss Kelly can talk about that.

              Bernadette Kelly: Yes, I think there is a tension, and this is an issue we need to continue to reflect on. Clearly, the more those lines are open to competition, the greater risk to franchise holders of revenue loss to them.

              In cases where individual companies wish to bid for open-access rights to a line, it is a matter for the ORR to determine what is the right and appropriate level of such access to allow, and it obviously does that independently. Separately, I know this is a question which the Competition and Markets Authority is looking into and has started to begin some analysis and workaround. We have challenged some elements of that analysis. We think it is very important in deciding how to strike a balance between open access and ensuring that franchise operators have a stable base for investment. There are direct affordability impacts on Government from a significant change, and that needs to be taken into account.

              Having said all that, it seems to me it is right that that debate is being had. It is perfectly appropriate and right that the Competition and Markets Authority should ask those questions. We will want to engage very actively in that dialogue going forward. Some of these questions may also surface in Nicola Shaw’s review, which, while it looks principally at the structure and financing of Network Rail, is opening up some wide questions about the structure of the industry at large as well.

              Q104 Nigel Mills: Travelling on East Midlands trains, I look quite jealously at what I see if I drive 40 minutes to the west coast main line. I see competition on the route, and I can get trains to London for £8 or something that I can’t possibly get on the line that I use. So I am wondering whether we need to have a policy that says, “Actually, we do want competition on the main lines into London,” and that when we let franchises, we’ll actually have that as our aspiration and people will be bidding on that basis, and we might even allow two franchisees to run the same route,  or something. That’s not what you have tried before generally. Do you think you need to be a little bit more prescriptive in trying to get to that, rather than just letting it drift?

              Bernadette Kelly: We haven’t taken the view thus far in the way that we have approached the franchising programme that doing it in the way that you described—seeking potentially two operators, rather than a single or principal operator—would generate better returns for the taxpayer or better outcomes for passengers. I guess that if a compelling case could be made that that was likely, then I’m sure we would want to reflect on how we structure the franchising accordingly.

              Q105 Chair: Ms Kelly, would Euston station be your territory, or is that Mr Rutnam’s territory?

              Philip Rutnam: Well, it affects all of us, actually. It depends on the question.

              Q106 Chair: The last time we looked at it, the cost of redeveloping Euston had risen from £1.2 billion to £1.6 billion; that was in 2013. Can you tell us the current estimated cost for redeveloping Euston station?

              Philip Rutnam: The proposal for Euston in relation to High Speed 2?

              Chair: Yes.

              Philip Rutnam: I am afraid that the best thing is probably for me to write to you. Sorry, I don’t have a figure in my head that I am confident about.

              Q107 Chair: Okay. That is slightly off the main subject, but not entirely.

              We have not touched much on passengers, although I think Mr Pugh got on to it a bit with some of the routes that he was talking about. Now there is this requirement to focus on the passenger experience. What do you think rail customers—passengers—will be able to see as a difference, Mr Wilkinson, now that that has been built into the franchise programme? What will our constituents say? “Wow! It’s fantastic now, compared with what’s gone before”?

              Peter Wilkinson: There is no immediate “now”.

              Chair: Ah, what a shame.

              Peter Wilkinson: Railways take a little bit of time to develop. However, very obviously today what we are seeing is an acceleration in the provision of train capacity.

              Q108 Chair: Seats for everyone?

              Peter Wilkinson: Absolutely. We’re already seeing new trains come into service, fleets being procured in franchising and regimes around the presentation of the products, and things that matter to people, such as the cleanliness of trains, and the safety and security of stations. We now attach very significant value to those things in franchise competitions. Whereas before specifications were largely won on price, we now have a very strong quality component.

              Q109 Chair: Is the provision of wi-fi part of the passenger experience that you are requiring of new franchises?

              Peter Wilkinson: It is, yes, and indeed Ministers have made very strong public commitments in that area, and I support those commitments. Wi-fi today is the equivalent of food and water; people just expect to be connected.

              Q110 Chair: We have touched on this before on this Committee: the benefits and the value, getting a seat—you mentioned the capacity issue—cleanliness. What about provision for bicycles? Is that something you consider in the new franchising agreement?

              Peter Wilkinson: A train is of a finite length and a finite width: there is only so much you can fit inside a tube. We are always trying to manage the trade-offs between the need for seating capacity and the space required for bicycles, and indeed for luggage itself. It is a complicated set of trade-offs—

              Q111 Chair: It wasn’t that complicated in the old days; it was just the guard’s van.

              Peter Wilkinson: But fewer people used the railways then. We are carrying double the number of people on trains today that we were carrying in ’95.

              Q112 Chair: So what is the maximum crowding level, the loading on trains? On the underground, “crush loading” is a well-used phrase. What is the maximum when you are setting out franchises? What is acceptable for passengers to stand for? Is it okay to stand all the way to Warrington or to Southport, for instance? I can accept that on a London train I might have to stand for a bit. What is the level? How do you measure it? And how can you explain this, so that we and our constituents—the passengers—know what they should expect?

              Peter Wilkinson: I need to write to you with the specific metrics—what we call PIXC, which is passengers in excess of capacity—for our railways. They vary according to the type of service it is. I would expect that on major inner metropolitan services, people naturally will stand more on trains than we would expect to see on long-distance routes, and therefore our crowding metrics—the benchmarks we set for crowding—vary according to the type of service and route.

              Q113 Chair: Given that we are seeing passenger growth, are you building in to the franchise growth for people to get seats?

              Peter Wilkinson: Absolutely. That is one of the core challenges we face today. We are growing at about 4% or 5% volume per annum. In some parts of the country, the figure can be much higher. These are tens of thousands, if not hundreds of thousands—

              Chair: We look forward to getting that in writing. Can you give us the rush hour figure and the standard figure?

              Sir Amyas Morse: It would be very helpful to have those. I know you have those numbers on existing franchises, so if we could have them for the last three years or so, we can see how they have changed.

              Q114 Chair: It would be very helpful, because I think that is what people who are watching this want to know.

              Is there anything you want to say on fares before we finish on this main part?

              Philip Rutnam: Just the point that I have already mentioned: that Ministers have made a very clear decision that regulated fares should increase at no more than RPI for the duration of this Parliament. There is obviously a financial cost to that, but that is a decision that they have made in recognition of the importance to users—to passengers.

              Q115 John Pugh: I think we all accept, having listened to what you have said today, that you are getting ever better at franchising, even though you are a little bit evasive about how much profit the TOCs are making out of you. You are aware, of course, of the fact that there is a whole devolution agenda going on, and that some franchising, such as Merseyrail, is already devolved, and Rail North are anxious to take over the franchising role that you currently occupy. I would like you to comment on that. Are you making any provision to ensure that the skills you have painfully acquired are transferred to relevant devolved bodies that may actually be the franchisers of the future?

              Peter Wilkinson: Yes. That is a very pertinent question. Franchising supports the agenda of devolution. We believe that combined regional authorities, which are beginning to emerge, are as well placed to specify services for their people as we are here in London. We have set about a number of discussions with these emerging authorities. Indeed, on the one you referred to in the north of England, we have a very clear partnership agreement which we have ascribed to with Transport for the North, which sets out how we will work jointly and together to meet the needs of local stakeholders and rail users in that part of the country and, indeed, to provide for the establishment and transfer of skills and knowledge that we have acquired through franchising. That is a process I would expect us to continue to apply to other devolved authorities.

              Philip Rutnam: May I just mention, in that context, the interesting example of Merseytravel and Transport for the North? London is doing this, and the same is planned in Wales. That is also a significant development, and one worth keeping an eye on.

              Q116 David Mowat: A final question on what we were talking about earlier, Mr Wilkinson, in terms of margin and returns that they were getting. Have you ever had a dialogue with anybody in one of these open-book contracts along the lines of, “You guys are making more money than you expected and than we expected you to make. We would like you either to do something for us on this contract or give us some money back”? Have you ever had one of those dialogues?

              Chair: You can just say no.

              Peter Wilkinson: We have never needed to have that dialogue, because the margins that are being earned are fair and reasonable. We have never encountered a situation, certainly while I have been involved with this, where that has arisen.

              Q117 David Mowat: So the contract has never turned out, in one of these contracts that you administer, to have been significantly better than expected for the franchisee, which would give rise to a discussion of that type.

              Peter Wilkinson: No, it has not.

              Q118 Chair: The direct awards, though, are doing better for them than if they were openly bidding. Is that fair to say? The taxpayer is not getting such a good deal with direct awards.

              Peter Wilkinson: The taxpayer is getting a good deal from direct awards. They are certainly getting a better deal than they would have done if we had just maintained the existing franchise in situ. The NAO’s Report lays claim to that. It makes it clear that the added value from direct awards is around 32%. It is correct that you get a higher value-added from full competition. That is absolutely right.

              Q119 Chair: Okay. Before we finish, I just want to ask Mr Rutnam about the garden bridge. The Department for Transport passported £30 million to Transport for London, but with some assurances attached. I’m not sure if that meant you could claw it back if there was a problem.

              Philip Rutnam: In certain circumstances, yes.

              Q120 Chair: So how do you feel the garden bridge is going? Are you worried about that £30 million of taxpayers’ money?

              Philip Rutnam: We continue to keep a very close eye on the garden bridge project. We were pleased to see the progress that was made between the London borough of Lambeth and the Garden Bridge Trust. Transport for London played an important role in helping to facilitate that outcome, and we were pleased to see that. Of course, a lot more needs to happen in relation to the garden bridge. They still need to get to the point of awarding their principal construction contract. If my memory serves me, there were—at least a couple of weeks ago—some outstanding land purchase issues, not with Lambeth, on the south bank. So we continue to keep a close eye on it. I know you have had some advice on this from the National Audit Office, which was in touch with us, so you will be familiar with the sorts of issues we considered before implementing the Chancellor’s decision that the bridge trust should be awarded £30 million by TfL.

              Q121 Chair: Is that taxpayers’ money safe if something goes wrong?

              Philip Rutnam: Thus far, only a proportion of that has actually been spent. We, of course, continue to keep a close eye on this.

              Q122 Chair: Can you tell us what proportion has been spent?

              Philip Rutnam: From memory, it is a little under £10 million.

              Q123 Chair: So about a third.

              Philip Rutnam: Part of the approach was to make sure the project could make progress, but our liability at this phase of the project is capped quite firmly.

              Q124 Chair: At the £30 million?

              Philip Rutnam: No. I believe at under £10 million. Perhaps I could write to you. Would that be helpful?

              Q125 Chair: Could you please write to us with an update?

              Philip Rutnam: Just to reassure you that we keep a very close eye on this important and valuable project.

              Q126 Chair: That £30 million may be small fry in the context of the hundreds of millions we are dealing with, but—

              Philip Rutnam: These are significant amounts of money.

              Chair: My colleague from Berwick, who has had to leave, told me that £5 million would do very nicely for a few major infrastructure projects in her constituency, so perhaps it is relative.

              May I thank you for coming along today? It is only recently that we did our report on Network Rail, which is now in the tent, so to speak. All these challenges on infrastructure, which are causing challenges for franchising, are within your purview, and it is within your power to resolve some of them. We recognise that some improvements and changes are on the right track, but you have heard our concerns about some of the uncertainties that remain. It is fair to say you share some of those, and it is quite heartening when you are open with us about that.

              We will be having you back to look at how franchising is going, and the Transport Committee is likely to look at that too at some point. I thank you for coming. The uncorrected transcript will be on the website in the next two or three days. You are welcome to look at that and to correct anything you wish. Our report will be out at some point in 2016.

              Oral evidence: Care leavers’ transition to adulthood, HC 411                            21