The West Coast fiasco points to the real problem with open public services

The West Coast mainline franchising fiasco shows that the current approach to outsourcing public services has serious flaws that need to be addressed – the much too complicated and secretive nature of outsourcing is the problem, rather than the people handling the process.

Last week Patrick McLoughlin, the new Transport Secretary, cancelled the West Coast Mainline franchise deal. The Department for Transport has been on a damage limitation exercise ever since, with McLoughlin blaming the fiasco on officials at the DfT “because of deeply regrettable and completely unacceptable mistakes made by my department in the way it managed the process”. Philip Rutnam, the Permanent Secretary at DfT, has also joined in telling staff that they must accept that the reversal was the fault of officials. Meanwhile, Kate Mingay, one of the three officials suspended by DfT (an ex-Goldman Sachs employee parachuted into the civil service because of her private sector expertise) has hit out at the way her role in the procurement has been portrayed by the Department.

Blaming officials is an easy way to distract from the substantive story: whether the current approach to franchising used by the DfT is fundamentally flawed. The Department argues that mistakes were made from the way the level of risk in the bids was evaluated due to human error – in particular the way in which inflation and passenger numbers were taken into account, and how much money bidders were then asked to guarantee as a result. But the assumptions about inflation and passenger numbers are dependent on the state of the UK and global economy and the ability of the future franchisee to bring in new customers. Colin Cram, writing for the Public Leaders Network, argues that: “…this enters the realms of guesswork and slight changes in assumptions can lead to different outcomes for contracts that may be for only three or four years, let alone 13.” If the Government’s own Office for Budget Responsibility continues to get its predictions on economic growth significantly wrong, how can we expect the assumptions made in the rail franchising process to be watertight?

This is not the first time that assumptions about economic growth and customer numbers has gone wrong, for example the previous experiences with the East Coast mainline or in the commissioning of welfare to work services. The Work Programme was designed for a far more positive economic climate than we now find ourselves in. DWP’s estimates of the number of customers in receipt of Employment Support Allowance have proven to be wholly unrealistic, with serious consequences for the business models of prime contractors and charities.

The risks associated with complex procurement processes such as the rail franchise are compounded by the secretive nature by which they are often conducted, behind a veil of ‘commercial in confidence’. As we’ve argued before, this ‘closed shop’ approach leads to poor decisions and a profound lack of public engagement – until something goes horribly wrong. The complexity involved also means a significant diversion of resources into the process of franchising rather than actual delivery of services. Franchising might work however if the process was more transparent and the assumptions about passenger numbers (and any other projections) were open to rigorous scrutiny by others outside of the process – so why isn’t it?

The West Coast fiasco has much wider implications that the policy establishment probably doesn’t want the public to consider. Cheryl Gillan, the former Conservative Welsh Secretary, has argued that a root and branch re-examination of the High Speed 2 rail project is needed if the public is to have trust in such a significant investment of public resources. Instead, plans for competition and outsourcing are being accelerated in prisons, probation services and health. In this context, the secretive, complex and bureaucratic nature of outsourcing needs to be addressed as a matter of urgency. If the public is going to be on board, then a public debate is needed on the merits and risks of delivering services in this way – which surely is what the Government’s open policy should be all about.

Fundamentally, the political establishment doesn’t engage the public in a debate about the merits of rail franchising because the public doesn’t support the idea. This ‘outsourcing by stealth’ approach wins neither hearts nor minds. Various surveys continue to show a strong majority of public opinion in favour of re-nationalising the railways – one recent survey found that 70% of respondents supported such a move. Impossible? New Zealand provides an example of such a policy put into action. Its rail and ferry network was privatised in the 1990s and asset-stripped and run down by an Australian outfit. It re-nationalised both in 2009. Michael Cullen, the then Finance Minister said privatization had “been a painful lesson for New Zealand”. Kiwi Rail in public hands has been able to invest in its long-term future whilst also generating significant financial and economic benefits for taxpayers in New Zealand.

Here, despite the strong public preference for a nationalised rail network, none of the three main political parties are committed to such a policy. At last week’s Labour Party conference, Ed Miliband and Maria Eagle made positive noises in this direction but no firm commitments. So we are left with an unpopular, risk-laden, fragmented rail network – and the policy establishment searching around for scapegoats when they should be looking somewhat closer to home.

On the railways (II): What lessons does rail privatisation offer open public services?

Rail privatisation offers a warning from history for the Government’s ‘open public services’ agenda to outsource more public services. In our previous post we suggested that rail privatisation has never been wholly accepted because the Major Government overlooked the essential ‘publicness’ of the railways. In this post we identify five specific damaging consequences of rail privatisation that should cause the current Government to consider much more carefully how it approaches outsourcing or risk repeating the same mistakes in other public services.

1. Expectations of greater efficiency from privatisation have not been realized

One of the principal expectations from privatisation was that the railways could be delivered more efficiently in the private sector because of the motive to generate profits. British Rail was already pretty lean following a cost cutting exercise in the 1980s, and in fact the opposite has occurred. The unit cost of the privatised rail industry is significantly higher than that of British Rail because economies of scale have been lost and the complexity of the industry has thrown up new costs. The public subsidy to the industry is considerably higher than it ever was for British Rail.

Chris Grayling when he was Shadow Transport Minister admitted that the way privatisation was organised “…helped push up the cost of running the railways – and hence fares – and is now slowing decisions about capacity improvements. Too many people and organisations are now involved in getting things done – so nothing happens. As a result, the industry lacks clarity about who is in charge and accountable for decisions.”

2. The rail industry has coalesced around a small group of large private sector providers who are (almost) too big to fail

The rail industry after privatisation was highly fragmented. This fragmentation has now been reduced but has resulted in a small group of private sector companies who now dominate the market. The complexity and scale of these contracts has skewed the market in favour of these large private providers who have the scale and deep coffers to absorb the risks associated with running a franchise.

Nonetheless, the narrowing of the market around this small group of providers is a risk. On three occasions, the state has had to step in and pick up the pieces because a company has pulled out of a franchise. The exit of Virgin Trains from the rail industry has further reduced the options available to government. Two of the recent new entrants to the rail market have been the national train operators of the Netherlands and Germany who have been accused of profiteering to subsidize their domestic operations. Where will the new train operators come from if another company fails or is judged to offer a poor quality service?

3. The private sector has profiteered from parts of the rail industry

To many people, private profit shouldn’t have a place in an industry that receives a £4 billion subsidy from the public every year and where consumer choice is highly limited. But there’s profit and then there’s profiteering. One of the publicly neglected aspects of rail privatisation is that running a Rolling Stock Leasing Company (or ROSCO) is a very lucrative business. Three were created as part of the break-up of British Rail and all are now owned by a combination of banks and private equity. ROSCOs have found older rolling stock to be especially commercially attractive as they can continue to generate revenue for stock even after the construction costs would have been written off by British Rail. This has also helped to inflate the fares paid by customers.

The privatization of ROSCOs is another example of the public sector selling assets at below their fair market value. The National Audit Office in a 1998 report stated that the UK Government had not realised fair market value for the sale of these assets. Eversholts Leasing later HSBC Rail was sold for £518 million in February 1996 but a year later the business was sold on for £726 million, a gain of some 40 per cent over the sale price by the Department for Transport.

More generally, train operating companies own virtually nothing, hiring most of the assets required from Railtrack and ROSCOs whilst also contracting out areas such as onboard catering and cleaning services. For this reason, Baroness Vadera, when she was a special adviser to Gordon Brown as Chancellor of the Exchequer, described the privatized passenger train operating companies as ‘thinly-capitalised equity profiteers of the worst kind’.

4. Privatisation led to a loss of skills and flexibility

The Hatfield disaster in October 2000 – caused by a broken rail as a result of faulty maintenance procedures – illustrated the loss of skills and flexibility from the rail industry as a result of privatisation. Railtrack, which had responsibility for rail infrastructure, had outsourced almost all of the maintenance and renewal of track. Outsourcing maintenance and renewal both removed flexibility (unless it was already included in a contract) and led to a drain of skills and knowhow from Railtrack. In the aftermath of the disaster, thousands of speed restrictions were imposed unnecessarily across the network because Railtrack did not have the expertise to know whether other parts of the track were also at risk of an immediate tragic failure. Railtrack was a disaster waiting to happen according to Christian Wolmar in his book On the Wrong Line: how ideology and incompetence wrecked Britain’s railways; the system it operated in was brittle and not designed to cope with sudden challenges. Hatfield sealed its demise and replacement by Network Rail, which has taken a different approach to maintenance by bringing some of this in-house again.

5. The views of users and frontline staff were sidelined

British Rail argued that if it was to be privatised then the rail network should be privatised as one entity. Instead the Treasury, under the influence of the Adam Smith Institute, advocated for the creation of 25 passenger railways franchises as a way of maximizing revenue. The effect of this was to create a complicated system with over 100 different companies delivering bits of the rail system, which made it difficult for the views of users and practitioners to be heard. Passengers were unclear on who was responsible for what or who to direct their questions or complaints to. Public accountability suffered as a result.

The views of passengers have also been neglected in franchise decisions. Passenger satisfaction targets in franchise agreements don’t carry sufficient clout. According to Passenger Focus, only 42 per cent of rail passengers are satisfied with value for money, yet increases in rail fares have continued this year despite the concerns raised by passengers. Given the amount of public money invested in the rail industry last year, as well as the cost of fares, surely the views of passengers should be at the forefront of rail policy?

The nationally-owned British Rail was far from perfect, but most people think that rail privatisation has been a relative disaster for the reasons discussed here. Rail privatisation represents a warning from history for a Government that seems intent on outsourcing more of our public services – will it learn the lessons?

On the railways: What lessons does rail privatisation offer open public services?

It’s been almost twenty years since John Major’s Government privatised British Rail, but unlike some other sell-offs the issue of who owns and runs our railways continues to attract widespread public controversy. In recent posts we’ve been looking at the tensions between the Government’s ‘open public services’ agenda for outsourcing and its ‘open policy’ agenda for greater transparency. In this post we suggest that rail privatisation has never been wholly accepted because the Major Government overlooked the essential publicness of the railways – a warning from history for the current Government’s attempts to outsource much of our public services.

Rail privatization is back in the news again with the announcement that Virgin Trains lost out to FirstGroup in its bid to continue to manage the West Coast mainline, a contract that Virgin has held since 1997. Richard Branson quickly offered up a withering criticism of the way the Department for Transport conducts its franchising arrangements for new passenger train operating companies (or TOCs). Branson has threatened that Virgin will walk away from the railway market for good, having spent £60 million on four thwarted bids, because (it says) it won’t play the game of offering up unrealistic performance targets to win business. Of course, this could just be regarded as sour grapes – but Branson is usually too savvy to let a knock-back make him seem like a bad loser. Rather, it’s best to assume he means it, and that his criticisms of the franchising process are heartfelt and somewhat accurate. If this is the case, how did we reach this point where Britain’s best-known businessman expresses so little confidence in what was supposed to be such a flagship privatization policy?

The 1993 Railways Act privatized the rail network. British Rail was broken up into over 100 different companies, with the complete separation of infrastructure (track, rolling stock, stations and signaling) from passenger train services. The latter were broken up into 25 different franchises (or contracts) leased to private sector passenger train operating companies. The number of franchises has subsequently been reduced, with a small group of private companies now dominating the market, including the likes of FirstGroup and the national rail companies of Germany (Deutsche Bahn) and the Netherlands.

Rolling stock, meanwhile, was transferred to three Rolling Stock Leasing Companies (ROSCOs), who were privatized and sold to private equity investors and banks including Abbey and the Royal Bank of Scotland. Rail infrastructure was transferred to Railtrack, which outsourced all maintenance and renewal to private contractors. Railtrack was quickly privatized in 1996 to prevent the unwinding of railway privatization by the incoming Labour administration. After the Hatfield rail disaster, Railtrack was sold to Network Rail and, remarkably, its current legal status is unclear with disagreement as to whether it is a public or private body. Franchising was also outsourced but was eventually brought back into the Department for Transport given the political sensitivities over the railways.

Proponents of rail privatization claimed it would improve quality and efficiency. While there are more trains on the network and there have been some improvements in safety, there have also been many downsides to privatization. There has been a significant rise in unregulated fares – particularly walk on tickets bought in stations or on trains. Costs have risen, since rolling stock is now leased from ROSCOs and construction costs would have previously been written off by British Rail. The unit costs of the privatized industry have risen significantly as the various train operating companies are not able to realize the economies of scale available to the previously national network. The complex nature of the industry has also watered down accountability and confused the general public (and no doubt often policymakers as well).

The numbers of passengers on the railways has also increased significantly but the start of this can be traced back prior to privatization. Factors such as the cost of petrol and increased road congestion could also help to explain this rise. Nonetheless, the public subsidy to the rail network has increased to about £4 billion in 2010/11 – down from a high of £6.5 billion in 2006/07 but far higher than what was given to the sector under public ownership. The effect of this has been to place an even greater burden on profitable routes such as the East and West Coast mainlines to return a significant dividend for the taxpayer – hence the reason perhaps that the Department of Transport has put so much faith in the highest bidders for these routes.

This faith hasn’t always been realized. Two operating companies, GNER and National Express, have handed back the East Coast franchise because they were not able to service the expected payment targets. Both providers over promised in order to win the franchise and ran into financial difficulties trying to deliver their plans. The result has been a legacy of under investment and cost cutting – which of course has ultimately cost passengers.

Richard Branson argues that the selection of the new franchisee for the West Coast mainline shows that the Department for Transport has not learnt the lessons from previous failures. The short-term political desire for a good headline has over-ridden the long-term interests of the network – and the concerns and opinions of rail users, despite active representation from passenger groups. But the broader lesson from this ill-conceived and rushed policy might be that some services need to be properly publicly accountable, even if not every aspect of them is delivered by the state. Does the current government understand the essential publicness of our public services?