LONDON: The Statioery Office 11.25 Ordered by the House of Commos to be prited o 28 November 2005 REPORT BY THE COMPTROLLER AND AUDITOR GENERAL HC 457 Sessio 2005-2006 2 December 2005
Part oe Summary
1.1 I Jue 2003, the Strategic Rail Authority (SRA) aouced that it would be termiatig, withi six moths, Coex South Easter s (CSE s) frachise for providig passeger rail services i Ket, parts of Sussex ad South East Lodo. This was the first, ad so far oly, occasio where the frachise of a Trai Operatig Compay (TOC) has bee termiated early. It had implicatios for passegers, taxpayers ad the rail idustry ad also raised issues about the govermet s approach to frachise maagemet. Implicatios for passegers: Coex South Easter held the secod largest passeger rail frachise i the UK ad employed some 3,500 staff. The services provided uder the frachise are amog the most complex ad demadig i the UK. Services call at 182 statios ad carry aroud 400,000 passegers a day, icludig some 120,000 durig each weekday peak, with may passegers depedig o daily commuter services to ad from Lodo. At the time of the termiatio of the frachise, CSE was also part-way through a programme of itroducig ew trais to replace 622 of its oldest trais icludig its 558 slam-door vehicles. 1 Implicatios for taxpayers: The SRA agreed to provide further subsidies of 58.9 millio for 2003 o top of cosiderable existig taxpayer subsidies of some 38 millio for that year, to stabilise CSE s fiaces. Implicatios for the rail idustry: The SRA demostrated to the rail idustry that it was both willig ad able to use its statutory powers, should the eed arise. As well as the immediate impact o CSE ad its employees, the termiatio had implicatios for TOCs ad their owig compaies, ad CSE s suppliers icludig the Rollig Stock Leasig Compaies (ROSCOs) that leased trais to CSE. Implicatios for govermet: Evets o the frachise raised issues about the effective maagemet of passeger rail frachises, which are ow relevat to the Departmet for Trasport ad the Scottish Executive as they take over the SRA s frachisig roles. 2 1 The Railway Safety Regulatios 1999 set TOCs a statutory requiremet to remove from service all of their oldest slam-door trais by December 2004. This deadlie was subsequetly exteded by Her Majesty s Railway Ispectorate (HMRI) util the ed of November 2005. 2 Uder the Railways Act 2005, the govermet is abolishig the SRA. I July 2005, the Departmet for Trasport took over the SRA s frachisig roles specifyig, awardig, maagig ad moitorig frachises, icludig moitorig TOCs compliace with frachise terms i Eglad ad Wales, while the Scottish Executive took over these roles i Scotlad i October 2005.
1.2 The SRA s predecessor, the Office of Passeger Rail Frachisig (OPRAF), awarded the frachise to CSE for a period of 15 years, to ru from 1996 to 2011. The frachise evisaged that OPRAF would pay CSE subsidies totallig 535 millio over the lifetime of the frachise. Aual subsidies would declie year o year, from some 125 millio durig the first 12 moths of the frachise util, i the fial 12 moths, CSE would pay OPRAF aroud 2.8 millio. I December 2001, CSE requested a two year extesio to the frachise suggestig that 400 millio of additioal subsidy be provided to improve its operatioal performace ad quality of service over the period to 2013, to brig it ito lie with frachises that the SRA was the cosiderig for two other TOCs. Subsequet work by the SRA ad CSE, however, idicated sigificat impedig fiacial difficulties o the frachise. 1.3 I December 2002, at the same time that it agreed to provide CSE with additioal subsidies for 2003, the SRA required improvemets to CSE s fiacial maagemet, particularly i the trasparecy of CSE s tradig with other busiesses withi the wider group of compaies of which CSE was a part, 3 brought forward the frachise s ed date from 2011 to 2006 ad etered ito egotiatios o possible further subsidies for 2004 to 2006. I Jue 2003, however, followig a series of reviews, the SRA aouced its decisio to termiate the frachise ad i November 2003 South Easter Trais (SET), a subsidiary of the SRA, took over the ruig of the frachise. 1.4 The SRA iteded that SET would ru the frachise for 18 moths before it relet the frachise to a private sector TOC. The relettig of the frachise has bee delayed, however, ad is ow scheduled to take place i December 2005. The ew frachise is expected to become operatioal i April 2006, by which time SET will have bee ruig the frachise for some two-ad-a-half years. The Departmet for Trasport (the Departmet) is relettig the frachise as part of a ew Itegrated Ket Frachise, combiig the services that SET curretly provides with ew domestic services o the Chael Tuel Rail Lik (CTRL), which are expected to begi operatig i 2009. 1.5 Govermet policy remais that Britai s passeger rail services are publicly fuded, where ecessary, but privately delivered. As it is ot a private sector TOC, SET has bee precluded from biddig for the ew frachise. The SRA decided that SET s maagemet team should ot put a bid together, because this might have distracted it from ruig existig services. SET will cotiue to ru the frachise util the Itegrated Ket Frachise commeces, at which poit the SRA will be fully woud up. What we examied 1.6 We examied: why the SRA termiated Coex South Easter s frachise; how much the termiatio cost taxpayers; the impact o passegers; ad the impact o the rail idustry, ad o the govermet s approach to frachise maagemet. 1.7 The mai methods used to obtai evidece for our report are set out i the Appedix. The source of CSE s fiacial difficulties was a ambitious frachise bid i respose to the govermet s emphasis o privatisig typically at the lowest level of subsidy 1.8 OPRAF awarded the frachise to CSE primarily because, at a time of growig competitio betwee bidders, CSE bid for the lowest level of subsidy over the frachise term. Aual subsidies were projected to fall over the lifetime of the frachise, most aggressively over the first three full fiacial years, ad CSE quickly ra ito fiacial difficulties. Rather tha achievig aticipated profit margis of 5 per cet aroud 15 millio a year betwee 1997-98 ad 2001-02, CSE achieved average margis of 1.7 per cet aroud 5 millio. It made a pre-tax loss of 2.4 millio i 2001-02 ad would have made a loss as early as 1998-99, the secod full fiacial year of the frachise, had its fiacial positio ot bee alleviated by rollig stock lease charges 20 millio a year lower 4 tha projected i its bid for the frachise. 3 Coex South Easter was owed by Coex Trasport UK Ltd, which i tur was part of Vivedi (ow Veolia), a multiatioal group of compaies. 4 I 1999, CSE re-egotiated its trai lease agreemets o more favourable terms, ad there was a delay i itroducig ew trais to replace its oldest slam-door vehicles. 2
1.9 Although over the first three years of the frachise CSE icreased its passeger ad other reveue ahead of the projectios i its frachise bid, its operatig costs icreased by 27 per cet compared with a aticipated fall of 11 per cet. Like other bidders, it uderestimated the extet to which British Rail had made efficiecies i preparatio for privatisatio. It employed more support ad reveue protectio staff tha plaed ad, i commo with other TOCs, had to employ more trai drivers ad sped more tha aticipated o wages, overtime ad driver traiig. 1.10 The SRA leared from the experiece of the earliest frachises, adoptig a ew policy of evaluatig bids to take accout of what was realistically deliverable, rather tha focusig primarily o lowest cost ad the maximum amout of risk that a bidder was prepared to take. The SRA applied this policy i awardig the four most recet frachises i 2004 ad 2005. I takig over the SRA s frachisig resposibilities, the Departmet has adopted the SRA s policy i awardig the Itegrated Ket Frachise, ad the Thameslik ad Great Wester frachises. The Departmet is, however, re-cosiderig its frachisig policy. It has reservatios about rejectig bids that offer the best deal for the taxpayer ad passegers i terms of price ad service provisio o the basis of civil servats ad cosultats assessmets of what is realistically deliverable, rather tha o bidders ow judgemets. It is therefore reviewig the case for such deliverability assessmets, which it aims to complete i time for ew ivitatios to teder for frachises from February 2006. CSE did ot alert the SRA to its emergig difficulties, while the govermet s approach to frachise moitorig relied o TOCs to assure their ow loger-term viability 1.11 CSE had become aware of its impedig fiacial difficulties i July 2001, but had sought to rectify matters itself rather tha brig them to the SRA s attetio. The philosophy of frachisig was that the fiacial risk was fully trasferred to private sector TOCs uder their frachises. OPRAF therefore expected TOCs to moitor their ow loger-term viability ad request a viability review 5 if ecessary. The frachise moitorig arragemets used by OPRAF focused o TOCs short-term solvecy. The arragemets did ot ivolve scrutiisig or challegig TOCs loger-term busiess projectios to assess their loger-term fiacial viability to deliver frachise obligatios. Whe the SRA was set up i February 2001, it iherited OPRAF s statutory duty uder the 1993 Railways Act to secure the provisio of passeger trai services. It had to be ready to step i at ay time, ad perhaps act as a operator of last resort if ecessary, to esure that services cotiued to ru. The SRA therefore cotiued with the frachise moitorig arragemets it iherited from OPRAF. 1.12 The magitude of CSE s fiacial difficulties oly became apparet after a series of reviews iitiated by the SRA after a request from CSE s holdig compay, Coex Trasport UK (CTUK) Ltd, for a two-year extesio to the frachise. But eve the CSE, ad cosequetly the SRA, could ot quatify the size of the fudig gap with ay certaity, with estimates ragig betwee 384 millio ad 820 millio. 1.13 The SRA leared from the CSE case, which showed that risks were ot fully trasferred through frachisig ad that there was residual risk to taxpayers ad passegers. The CSE case cotributed to chages i the SRA s frachise maagemet approach. The SRA stregtheed its ability to scrutiise ad iterpret fiacial iformatio, idetify problems three to five years ahead ad uderstad the risks to the taxpayer. The SRA required TOCs to provide more fiacial ad maagemet iformatio ad it subjected such iformatio to a greater degree of challege. The SRA s revised frachise moitorig reports cotiued, however, to focus o TOCs shorter-term performace ad, i our view, the reports still did ot give sufficiet attetio to TOCs loger-term fiacial viability. 1.14 The abolitio of the SRA ad the Departmet for Trasport s assumptio of the SRA s frachisig resposibilities preset risks to the cotiuity ad rigour of frachise moitorig. The Departmet told us that it will be adoptig the SRA s policy i takig over the SRA s frachisig resposibilities, but is focusig further o idetifyig the key risks facig each frachise. I its July 2005 report, Network Rail: makig a fresh start (HC 556 2004-05), the Committee of Public Accouts recommeded that, i takig o its ew resposibilities, the Departmet should recruit eough staff with commercial ad techical skills ad with the stature ecessary to deal effectively at the highest levels of the railway idustry. Comparisos betwee the umber of staff employed by the SRA ad by the Departmet o 5 A TOC ca request a viability review of the terms of its frachise agreemet if it cosiders that compliace with its obligatios would result i default before the ed of the frachise term.
frachisig issues are ot straightforward, because the SRA orgaised its team i a differet way to the structure that the Departmet has ow adopted for its teams. Focusig specifically o those staff most closely ivolved with the maagemet of frachises, we foud that the Departmet s staffig complemet was 15 per cet less tha that of the SRA. All but six of the 79 staff curretly i post are former SRA employees. CSE failed to satisfy the SRA that it was takig vigorous actio to improve its fiacial maagemet as a matter of urgecy 1.15 A series of reports carried out by a cosultat from Mott MacDoald o behalf of the SRA betwee Jauary ad March 2003 foud that CSE had ot complied with its obligatios to improve its fiacial maagemet, cotrol ad reportig. Ideed, CTUK Ltd told us that, because it had cotributed 11.1 millio of its ow moey to stregthe CSE s frachise, it saw the 58.9 millio of additioal subsidy agreed for 2003 as a SRA vote of cofidece i the TOC as a prelude to egotiatig a stable fudig arragemet to the ed of the frachise, although the SRA ever expressed its agreemet to the deed of amedmet i such terms. CSE therefore focused more of its attetio o egotiatios o possible further subsidies, ad its proposals for reducig costs for 2004 to 2006, tha o the SRA s immediate requiremets for improved fiacial maagemet. The SRA s approach did ot produce coclusive results, ad the SRA had to egage auditors to determie CSE s compliace 1.16 The three moths betwee Jauary ad March 2003 were a critical period for CSE to demostrate its compliace with its obligatios. The SRA expected CSE to comply with its obligatios, but secoded a cosultat from Mott MacDoald to moitor CSE s compliace. The SRA spet 163,000 o the secodee ad SRA staff held regular meetigs with CSE. But the extet ad ature of the egagemet betwee the SRA ad CSE were uclear from the documetatio we have see, ad the SRA s approach, particularly the cosultat s reports, did ot produce coclusive results. I particular, we foud o evidece as to whether the SRA had approved the required programme of fiacial maagemet improvemets that CSE had submitted to the SRA o 15 Jauary, or formally shared with CSE the cosultat s report highlightig the deficiecies i the programme, ad o which CSE s subsequet work to improve its fiacial maagemet depeded. Further, the cosultat s reports relied heavily o statemets of compliace from CSE itself, without ay idepedet verificatio, which the SRA had ot asked the cosultat to provide. The cosultat s March 2003 report did ot provide the SRA with a reliable view of the extet of CSE s compliace with its obligatios. By the, the SRA cosidered that termiatio was a real possibility but that the cosultat s report did ot provide a robust basis for it to take vital loger-term decisios o the frachise. The SRA therefore commissioed PriceWaterhouseCoopers (PWC) to assess CSE s compliace, at a cost of some 177,000. Although CSE made some improvemets, the SRA ultimately lost cofidece i CSE ad issued a termiatio otice 1.17 I their May 2003 report, PWC cocluded that CSE had bee slow to focus o the deed s requiremets ad was ot compliat with five of them. I respose, CSE subsequetly provided evidece of compliace i three of these five areas. PWC also cocluded that CSE s budget-settig ad review process had o sigificat weakesses ad was comparable with other compaies of a similar size ad complexity, ad did ot idetify ay istaces where CSE was fiacially supportig the other busiesses withi the wider group of compaies of which CSE was a part. 1.18 PWC recommeded that the SRA should ot provide additioal subsidy for 2004-06 uless CSE addressed certai key actios, icludig some that had bee required uder the deed of amedmet. They also recommeded that CSE be required to appoit a Fiace Director with sole resposibility for the TOC (whereas the existig Fiace Director worked for both CSE ad its holdig compay, Coex Trasport UK Ltd) ad a compliace officer resposible for addressig the SRA s requiremets ad esurig full ad timely compliace with fiacial cotrols. CTUK Ltd appoited a ew Maagig Director of CSE, ad a compliace officer, both of whom bega work i May 2003. CTUK Ltd told us that, i the same moth, it had iformed the SRA that it was appoitig a ew Chairma, who was highly regarded withi the rail idustry, to take whatever actio the SRA required of CSE. But, by the, the SRA had lost cofidece i CSE s fiacial maagemet ad it was too late for CSE to regai it. The SRA had provided fudig to other TOCs i fiacial difficulty, but the SRA s loss of cofidece was uique to CSE. 4
1.19 CSE had egaged cosultats to help it develop a improved fiacial model, as required by the SRA, ad aother set of cosultats at a cost of 400,000 to idetify ways of reducig costs ad miimisig CSE s call o the public purse. CSE preseted its ow proposals for reducig costs ad the amout of subsidy it eeded, which it estimated could yield aual savigs of some 20 millio. It proposed ruig fewer carriages o off-peak services, istallatio of more ticket vedig machies at statios to reduce staff costs, combiig retail ad ticket-sellig operatios, reducig trai leasig charges by extedig leases o better terms ad moutig CCTV cameras o may trais to replace coductors. By March 2003, the SRA was satisfied that CSE s fiacial model for 2004 to 2006 produced accurate calculatios, but remaied ucoviced as to the robustess of the projected costs ad reveues. The SRA was also ucoviced that CSE would be able to deliver its proposals for reducig costs. It cosidered the proposals impractical because they would require sigificat ivestmet i 2003-04 ad that some might costrai the commercial iterests of a icomig frachisee. 1.20 The SRA cosidered that CSE s progress was isufficiet for it to regai the cofidece lost over the previous year. It cosidered that othig Coex had doe sice the begiig of 2003 with regard to fiacial maagemet had demostrated either urgecy or a ability to chage behaviour so as to produce a culture of compliace. The maagemet effort required by the SRA to spot ad maage errors ad deficiecies had bee disproportioate compared with both other frachises ad other SRA fuctios. I particular, the SRA was cocered that CSE s maagemet was isufficietly pro-active ad trasparet i its dealigs with the SRA ad that it focused o meetig the reportig eeds of its paret compay, givig a lower priority to meetig the eeds of the SRA. 1.21 Papers submitted to the SRA Board icluded all of the key iformatio that we would have expected the Board to take ito accout, except for metio of the recet appoitmet of CSE s ew Maagig Director ad recruitmet of the ew Chairma, ad the PWC report i full. The SRA told us that the Board kew that the ew Maagig Director had take up post. The lead fiacial adviser from KPMG atteded the Board meetig. He told the SRA Board that CSE s fiacial maagemet regime was very weak ad that it could ot be assured that CSE would sped additioal fuds efficietly ad ecoomically, as required by the Trasport Act. The SRA Board approved termiatio of the frachise. He told us that he gave his advice i the cotext of the material available to the Board ad of the level of cofidece i CSE s fiacial maagemet that the SRA required. 1.22 I our view, there were weakesses i CSE s fiacial maagemet, cotrol ad reportig, but we cosider that KPMG expressed the weakesses i CSE s fiacial maagemet regime i stroger terms tha is supported by the evidece we have see. We cocluded, however, that the Board had cosidered most of the key, relevat iformatio ad that the papers preseted to the Board had bee carefully balaced i settig out both the evidece ad the optios for the Board s deliberatio. It was appropriate for the Board to exercise its statutory duty uder the Trasport Act ad decide to termiate the frachise, where it had lost cofidece i CSE s ability to use additioal subsidy efficietly ad ecoomically. 1.23 The SRA Board recogised that termiatio of CSE s frachise would sed a very strog message to the idustry, idicatig the seriousess with which the SRA was udertakig its resposibilities. We foud that the termiatio decisio prompted some TOCs to coduct their ow iteral reviews of their compliace with SRA requiremets ad of their fiaces ad fiacial maagemet. But the decisio otherwise had a limited impact o the rest of the rail idustry. Much of the idustry believed that the Departmet would termiate a frachise agai should the circumstaces require it. The SRA trasferred the frachise to SET i a short space of time ad secured a reasoable fiacial settlemet with CSE 1.24 The termiatio was ot straightforward. CSE had 42 primary cotracts with its suppliers, i additio to its leases with Network Rail for statios, depots ad related property, makig a total of over 3,000 cotracts. The SRA acquired oly assets ad liabilities related directly to the provisio of trai services. The SRA completed the exit egotiatios ad eabled SET to take over operatios i early November 2003, less tha five moths after aoucig the termiatio i Jue 2003. The SRA secured a reasoable fiacial settlemet for CSE s exit from the frachise, with CSE payig SET 15 millio i settlemet for the et liabilities trasferred to SET. 5
SRA costs recharged to CSE, ad CSE costs reimbursed by the SRA Nature of cost Cost SRA costs recharged to CSE Cosultacy costs icurred by the SRA 2.6 millio Media costs associated with the SRA s aoucemet of the termiatio 106,000 The cost of Network Rail carryig out a dilapidatios survey of CSE s frachised statios o behalf of, ad paid by, 98,000 the SRA. Total SRA costs recharged to CSE 2.8 millio CSE costs reimbursed by the SRA Additioal operatioal costs icurred by CSE because of the early termiatio, icludig: 600,000 the higher costs of isurig CSE s rollig stock, reflectig higher premia charged for reewig the isurace policy for a short period of time util termiatio; termiatio paymets ad legal costs relatig to two CSE staff, icludig the Fiace Director who resiged i September 2003; ad salary ad other costs of a ew Fiace Director, from his takig up post i October 2003 to the trasfer of the frachise to SET i November 2003, ad the costs of recruitig aother member of staff. Source: Natioal Audit Office summary of SRA iformatio The SRA oly recovered the costs that it cosidered it could reasoably recover ad reimbursed CSE for some of its costs 1.25 Uder the terms of the frachise agreemet, the SRA had a cotractual right to recover from CSE sums it cosidered reasoable for the losses, liabilities, costs ad expeses it icurred or was likely to icur as a result of CSE s failure to comply with its obligatios. The SRA recharged 2.8 millio to CSE, mostly relatig to the cost of cosultats assistig with the high risk busiess, fiacial, legal ad commuicatios issues associated with the termiatio. 1.26 But the SRA icurred other costs totallig at least 3.8 millio that it decided ot to exercise its cotractual right to recover from CSE. The SRA reimbursed CSE some 600,000, icludig higher isurace costs ad staff-related costs. The SRA decided to reimburse CSE for these costs as they arose directly from its decisio to give otice of termiatio. The SRA did ot recover from CSE: some 600,000 of costs associated with creatig SET ad its holdig compay, SET (Holdigs), cocerig re-bradig icludig ew staff uiforms ( 274,000) ad IT costs ( 326,000); retetio paymets of 557,000 to key CSE staff; ad the costs of its ow staff time spet i maagig the evets o the frachise. There was the extraordiary work ivolved i maagig CSE s frachise i the period leadig up to the termiatio decisio, which was disproportioate compared with what SRA staff ormally did i dischargig their statutory duties i maagig other frachises. The SRA did ot record or estimate the cost of this additioal work. There was also the termiatio itself, o which a core team of te SRA people worked alogside cosultats full time for six moths o the busiess, fiacial, legal ad commuicatios issues associated with the termiatio. The SRA did ot record the time spet, but estimated the cost of this team to be i the regio of 500,000. The work did ot etail ay cash costs, but a opportuity cost to the SRA because of the sigificat additioal work for staff. 1.27 The SRA decided ot to ivoke its cotractual right to recover these costs, as it was cocered about the sigificat fiacial ad operatioal risk of CTUK Ltd becomig isolvet i the face of such claims. The SRA told us that isolvecy might have triggered third party rights to the assets ad sums trasferred from CSE to SET as part of the fiacial settlemet. 6
1.28 Nor did the SRA recover the 2 millio that it spet o the several cosultats reviews of CSE s fiacial difficulties ad the extet of CSE s compliace with the terms of the deed of amedmet leadig up to the termiatio decisio. Oral advice from the SRA s iteral legal advisers was that these costs had bee part of the SRA s routie day-to-day maagemet of the frachise ad that the SRA had o cotractual right to recover them from CSE. The SRA believed that o useful purpose would be served i seekig to recover costs that it had o cotractual right to recover, ad that doig so would have udermied already difficult exit egotiatios ad icreased the risk of CTUK Ltd becomig isolvet. 1.29 Give the extraordiary work ivolved i maagig CSE s frachise i the period leadig up to the termiatio decisio, o accout of CSE s failure to satisfy the SRA s requiremets, we cosider that the SRA should have doe more to test the case for recoverig such costs, with the support of idepedet ad formal legal advice, particularly as this case set a precedet for the govermet should it decide to termiate other frachises early i future. O a like-for-like basis, SET might cost less tha estimated at the time of termiatio 1.30 Whe it decided to termiate CSE s frachise, the SRA estimated that a replacemet frachise ru by a SRA subsidiary would require some 425 millio i subsidy for 2004 to 2006. Based o actual costs from November 2003 to the ed of March 2005 ad projected costs to December 2006, the SRA expects SET to cost the taxpayer 403 millio some 22 millio less tha origially aticipated to ru the frachise over this period. But comparisos betwee the actual ad likely cost of SET ad what was origially evisaged are ot as straightforward as this compariso suggests. Based o actual costs to March 2005 ad projected costs, we estimated that o a like-for-like basis SET might cost the taxpayer 12 millio (2.9 per cet) less tha the amout the SRA estimated if SET were to ru the frachise util December 2006. The frachise is likely, however, to be relet as part of the Itegrated Ket Frachise to start from April 2006. We estimate that, o a like-for-like basis, SET might cost the taxpayer 6 millio (2 per cet) less tha the amout the SRA estimated if SET were to ru the frachise util the ed of March 2006. SET s costs to the taxpayer have therefore bee well cotrolled to keep them i lie with the SRA s origial estimate. Based o the efficiecy measures used by the SRA ad iherited by the Departmet, SET was i lie with its two comparator TOCs i Lodo ad the south east i 2004-05. O a like-for-like basis, SET might cost more tha the subsidies that CSE was prepared to accept to operate the frachise 1.31 The SRA s estimate that a SRA subsidiary might require subsidy of 425 millio reflected its ow assessmet of what a robust operator might require, ad icluded the 42 millio of additioal costs that it cosidered might be icurred from recruitig ad employig staff o short-term cotracts ad employig advisers as the SRA had o previous experiece of maagig a frachise. At the same time, the SRA had bee i egotiatio with CSE over the level of additioal subsidy for 2004 to 2006. CTUK Ltd had told the SRA i Jauary 2003 that it would eed additioal subsidy of 250 millio for 2004 to 2006, over ad above the existig subsidy of 200 millio uder the origial frachise agreemet. The SRA had subsequetly, through egotiatio, drive dow to 183 millio the amout of additioal subsidy that CSE was prepared to accept. CSE was therefore prepared to accept subsidies totallig 383 millio to operate the frachise util December 2006. 1.32 We estimate that, o a like-for-like basis, SET might cost the taxpayer 30 millio (8 per cet) more tha the amout that CSE was prepared to accept by way of subsidy if SET were to ru the frachise util December 2006. O a pro-rata basis, SET might cost almost 22 millio (8 per cet) more were it to ru the frachise util March 2006. The SRA had little cofidece, however, that CSE would be able to ru the frachise withi the 383 millio it was prepared to accept. The SRA had bee cosiderig placig CSE o a maagemet cotract, like that for other TOCs i fiacial difficulty, which would have provided some meas of cotrollig CSE s costs ad subsidy. The SRA cosidered that it would have bee difficult placig CSE o such a cotract, however, give the SRA s lack of cofidece i CSE s budgetig ad forecastig. 7
SET is workig to reduce the 16 millio that it estimates it is losig each year through fare evasio 1.33 As a subsidiary of the SRA operatig o a maagemet cotract, 6 SET s losses from fare evasio result i lower surpluses, reducig the public moey available to be surredered to the SRA or ivested i SET s busiess. The SRA recogised that reveue risk would retur to the SRA upo the frachise beig take i-house. 1.34 The SRA expected TOCs to maage, rather tha completely elimiate, fare evasio, expectig that betwee 2.5 per cet ad 3.5 per cet of travel o each TOC s services would be ticketless. Estimates of the level of evasio across the etwork vary: the SRA estimated that it lay betwee 3 ad 6 per cet depedig o differet routes ad services, equatig to lost reveues of betwee 120 millio ad 235 millio a year; ad, i April 2005, the Miister for Trasport told Parliamet that over 200 millio of reveue was lost aually. SET has estimated that it loses 16 millio a year as a result of fare evasio, represetig 4.8 per cet of its aual passeger icome or 19.8 per cet of its aual direct subsidies of 81 millio. This is greater tha the level of ticketless travel that the SRA expected TOCs to achieve but withi the rage it had estimated across the etwork as a whole. 1.35 The SRA expected that SET would maage the risks of fare evasio as part of a more geeral improvemet i the ruig of the frachise ad therefore it did ot require SET to stregthe its reveue protectio measures whe it took over from CSE. SET would have to sped to save, ad therefore ot all of the 16 millio is recoverable. SET s holdig compay approved budgets for SET that icluded 2.5 millio for additioal reveue protectio measures i 2004-05 ad 2005-06, ad SET has stregtheed its reveue protectio activity where its holdig compay has approved the busiess case for measures that it cosiders to be cost effective. The measures were expected to be self-fiacig withi three years of implemetatio. SET has, for example, appoited additioal reveue protectio staff ad exteded its pealty fare area. SET spet 500,000 o additioal measures i 2004-05, ad expects to sped 780,000 o additioal measures i 2005-06. It recovered 219,000 (1.4 per cet of estimated aual losses) more i pealty fares i 2004 compared with the sum that SET ad CSE together had recovered i 2003. It aims to recover a additioal 500,000 (3.1 per cet of estimated aual losses) i 2005. Reveue protectio staff have a deterret effect, leadig to more passegers payig at ticket offices, although by its ature this effect caot be quatified. Most recetly, however, SET has aouced plas to recruit fewer additioal reveue protectio staff tha it had aticipated, ad to istall istead automatic ticketig gates at some of its statios at a capital cost of 900,000. It plas to complete their istallatio by March 2006. CSE s operatioal performace deteriorated a little, but its customer satisfactio levels improved slightly, durig the high risk hadover period 1.36 CSE s operatioal performace i the period leadig up to Jue 2003, whe the SRA aouced the termiatio of the frachise, was i lie with that of comparator TOCs. But this was maily due to Network Rail recoverig from low levels of performace. There was a real risk, heighteed by CSE s itroductio of a icreasig umber of ew trais oto the etwork, that services might deteriorate i the period ruig up to SET takig over the frachise i November 2003. CSE s operatioal performace deteriorated, while overall passeger satisfactio icreased, a little durig the hadover period. Network Rail was the sigle biggest cause of the deterioratio i CSE s operatioal performace, although CSE itself was the ext largest. 6 The SRA placed TOCs o maagemet cotracts whe they had fiacial difficulties, the SRA bearig more fiacial risk ad moitorig more closely a TOC s reveue ad costs tha uder ormal frachise agreemets. The ature of maagemet cotracts has varied, but may have bee cost plus cotracts, whereby the SRA paid the TOC a agreed margi o the costs the TOC expected to icur.
Passeger trai services ad passeger satisfactio have improved uder SET, but most of the improvemet i performace has bee due to Network Rail recoverig from low levels of performace 1.37 The SRA equipped SET to maage the frachise effectively from the day it took over from CSE. Uder SET, operatioal performace has improved i lie with that of similar Lodo commuter TOCs, although improvemets i Network Rail s performace have made the biggest sigle cotributio to reduced delays o trai services across the atioal rail etwork ad for SET ad its comparator TOCs, as Network Rail cotiued to recover from low levels of performace after the Hatfield derailmet i October 2000. Sice April 2004, SET ad its comparator TOCs, have also cotributed to the improved performace despite itroducig ew trai fleets, which have historically bee less reliable i the first moths of operatio tha the old trais they replace. Passeger satisfactio has also improved ad i the most recet Natioal Passeger Survey it had reached the highest level for the South Easter Frachise sice the Survey started. Like CSE before it, however, SET has oe of the lowest passeger satisfactio ratigs of all TOCs. Value for moey coclusio 1.38 The SRA termiated the CSE frachise because it did ot believe it would get value for moey from the hudreds of millios of pouds of subsidy CSE eeded to ru the frachise util 2006. Although termiatio resulted i higher subsidies for South Easter Trais temporary operatio of the frachise tha CSE was prepared to accept, the SRA did ot have cofidece i CSE s ability to maage withi the proposed subsidies. Overall, the case demostrates that the SRA s powers, ow assumed by the Departmet for Trasport, ca be used successfully to termiate frachises that perform usatisfactorily. The ew arragemets provide the basis o which the icomig frachisee for the Itegrated Ket Frachise, whe chose, will have the opportuity to demostrate value for moey.
recommedatios 1.39 The SRA leart lessos from the CSE case, ad also from evets o other frachises, ad took actio to stregthe its approach to frachise award ad frachise maagemet. With the trasfer of the SRA s frachisig roles to the Departmet for Trasport, there are lessos that the Departmet eeds to be aware of ad build o as it iherits the legacy left to it by the SRA: a b c The Departmet should complete its review of its approach to the awardig of future frachises ad, if it decides to abado its assessmets of whether bids are realistic ad deliverable over the lifetime of the frachises, it should clearly defie the criteria ad coditios uder which it would be prepared to provide additioal subsidies to TOCs experiecig fiacial difficulties. The Departmet would also eed to have available at short otice eough people with the right skills to take over a failig frachise ad cotiue to ru the trais. The Departmet should review the o-goig viability of frachises at regular itervals, rather tha rely o TOCs requestig a viability review if circumstaces chage from those origially evisaged. The Departmet should target its requests for iformatio from TOCs ad its moitorig of TOCs fiaces over the short ad loger term based o the risks preseted by idividual TOCs i order to idetify emergig problems early ad head them off before they become acute. d e f g h The Departmet should build o the traiig that the SRA provided to its staff ivolved i frachise maagemet, to embed the skills, experiece ad capacity ecessary for effective oversight of TOC fiaces. The Departmet s frachise moitorig reports should place particular emphasis o TOCs loger-term fiacial viability to deliver their frachise obligatios over the followig three to four years i additio to their more immediate fiacial situatio. Particularly where it has cocers about iformatio a TOC has provided, the Departmet should quickly brig them to the TOC s attetio so that the TOC may act quickly o the issues it eeds to address. Particularly where difficulties arise o a frachise, the Departmet should provide the TOC cocered with formal feedback o progress ad developmets, ad should documet clearly the extet ad ature of its liaiso with the TOC. The Departmet should establish, with the support of formal idepedet legal advice, the full rage of costs icludig the cost of its ow staff time that it may recover from TOCs upo the termiatio of a frachise, i preparatio for ay future frachise termiatios. It should also do this i respect of ay costs for which it should i tur reimburse TOCs. Where the cost of its ow staff time may be recovered, the Departmet should put appropriate recordig systems i place to support its rechargig. 10
i j The Departmet should review the level of fare evasio beig experieced by those TOCs that are curretly operatig uder a maagemet cotract ad their reveue protectio measures, ad assess the busiess case for ivestig i stroger measures to reduce fare evasio ad losses to the taxpayer. The Departmet should brig this report to the attetio of the Scottish Executive, which has recetly acquired the SRA s resposibility for passeger rail frachisig i Scotlad. 11