What derailed the Transport Department

 
Sir Richard Branson Sir Richard Branson's Virgin fought the Department's decision to award the franchise to First Group

In awarding a contract to run a public service, such as a railway, there is a balance to be struck between making the contract long enough to encourage serious investment and not so long that the forecasts built into bids for the contract become highly speculative.

What the Department for Transport appears to have got chronically wrong in the case of the West Coast Main Line franchise is its assessment of the risk that attaches to projections by bidders of revenues in the latter years of the 15-year franchise.

To put it in terms that we can all understand, if I expect to earn a pound from my work tomorrow, that pound is much more likely to materialise than a pound that I might expect to earn in 2025 (if anyone will still employ me then).

By extension, when First Group and Virgin made their bids to run the line that connects London with Manchester and Glasgow, it would have been reasonable to expect the Department for Transport to put a much greater weight on revenues the companies expect to generate in the first five to ten years than in the latter five years.

However the Department seems to have understated the long-term risks when awarding the contract to First Group.

Or to put it another way, the Department made unrealistic assumptions about the growth of passenger numbers and inflation towards the back end of the franchise period - which had the effect of making First Group's bid seem significantly more attractive, because First Group was massively more optimistic about how passengers and revenues could grow after 2021 than was Virgin.

This error seems to have occurred both when Virgin was eliminated from the bidding contest, and when First Group's bid was reassessed against the Department's own forecasting model for future revenues.

The basic point is that although there are powerful arguments for awarding longer term contracts, so that the successful bidder has an incentive to spend serious money on the best kit, a healthy scepticism needs to be attached to forecasts of the health of the economy and of the relevant public service over a time period as long as three parliaments.

Without such healthy scepticism, the government would tend to demand too little in the way of guaranteed money for taxpayers from bidders who are particularly optimistic about long-term prospects.

UPDATE 16:20 BST

Rarely if ever in the history of private provision of public services has there been such a bungle by Whitehall in the awarding of a highly valuable and important contract.

There appear to have been two giant errors by the Department for Transport in the way it adjudicated on who should receive the 15 year contract to run the West Coast Main Line.

First it unfairly discriminated against the incumbent, Virgin, by attaching far too great a probability to the projections by the rival bidder First Group that its revenues in the later years of the contract would be much bigger than Virgin's.

This mistake was compounded in the department's own internal forecasting model, which also attached too little risk to the possibility that passenger numbers and inflation would be significantly different from what First Group was projecting after 2021.

As a result, the government demanded too little guaranteed money for taxpayers from First Group.

But perhaps all this can be forgiven as an unfortunate technical error. What is perhaps more shocking is that Virgin has been complaining about the flaws in the bidding process for months, and yet the government pressed on with awarding the contract to First Group.

It was only after Virgin demanded a judicial review - after it sued - that the department was forced to acknowledge that it had made an egregious error.

Junior heads may now roll - in that three department officials have been suspended. But some would say that it is incumbent on the permanent secretary, Philip Rutnam, and the previous transport secretary, Justine Greening - reshuffled out only last month - to explain how they came so close to awarding a contract worth around £5bn on such a flawed basis.

 
Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this
    +2

    Comment number 143.

    At the heart of these issues is the Treasury.

    The same treasury whose incompetence created the bubble economy that led to the crash even though it was warned that its action would inevitable lead to disaster.

    The past head of the treasury now wants the run the Bank of England as a retirement job! He should be stripped of all his awards, knighthoods & his peerage and made to pay for his actions!

  • rate this
    +5

    Comment number 142.

    "Who's most to blame? Lying executives, or conniving officials?"

    INCOMPETENT MINISTERS, that's who!

  • rate this
    +6

    Comment number 141.

    Remember the Irish EU referendum - if you don't get the result you want, keep holding it until you do! Since Virgin's bid was in second place and the discounted long term profits from First Group's bid have now been debunked, you'd have thought that Virgin would automatically win the bid. But no, we now have to go through the process again! It seems to me some FG cronies are calling in favours!

  • rate this
    +1

    Comment number 140.

    The Civil Service - our unelected permanent government has ruined the country far more certainly than any of the political parties.

    The can't competently buy hospitals, materiel, computer systems, trains - in fact any state purchase. They all need sacking and made to get a real job where if the act incompletely they will suffer the consequences.

    Of course they will get away with it yet again!

  • rate this
    0

    Comment number 139.

    Renationalisation is urgently required

  • rate this
    +3

    Comment number 138.

    Apparently there are people on this blog who want to give vast sums of taxpayers' money to their friends in the city. (Score on 66)

    There people should not be given the oxygen of publicity for their appallingly selfish (Tory/libertarian wing) views. These people are usurping the state and need to be expunged by all decent society! They are robbing us and we must stop them on the railways, etc.

  • rate this
    -2

    Comment number 137.

    The whole privatisation process was flawed. Money into the treasury was the only consideration at the time. The result is a very inefficient network that costs a fortune to administer. It is too late to rehash the whole operation so the government can only make the best of a bad job.

  • rate this
    +8

    Comment number 136.

    First group already runs Manchester--Edinburgh services along the West Coast main line and crams passengers into suburban trains with inadequate toilet accommodation, for a journey of over three hours. This to me is a disqualification from running any other West Coast services.

  • rate this
    +2

    Comment number 135.

    In reply to Acet, First group did did not walk out of an agreement and reneague on a contract. The contract on Geat Western allowed them to not opt for the last three years of the franchise, unlike National Express which threw in the towel once the payments eat into their profits.
    I hate these merry-go-round of franchises with in built profit margins but the facts need to be just that.

  • rate this
    +3

    Comment number 134.

    So. the party of millionaire toffs who've never done a day of real work in the lives and no very little about business have completely cocked up. No surprise there. Still, no doubt they will recover the £40m of taxpayers money from somewhere. What about cutting nurses pay to cover it?

  • rate this
    +3

    Comment number 133.

    Meanwhile the banker scum is laughing at us plebs

    Record low interest rates & the banker scum is raking it in as charging borrowers AND savers a 100% + profit rate on the basic interest rates

    Never been a better time to be banker scum!

  • rate this
    +7

    Comment number 132.

    The story is simply this. A grossly underfunded BR is privatised & a Tory Government ensures it's new owners receive even more in subsidies than the old BR even when showing a profit.
    We have just arrived in Paris having travelled on a SNCF TGV from Marseilles at speeds of up to 200 mph on a train made up of two double decker sets. It makes me want to weep.

  • rate this
    -3

    Comment number 131.

    119. ComradeOgilvy
    The reason the franchises are divvied up this way is because some lines simply aren't profitable, so to keep them open they're sold off as part of a package that includes 'good' lines.
    -----------------
    Unprofitable lines become profitable with sufficient subsidy. Actually they are nearly all unprofitable.

  • rate this
    +1

    Comment number 130.

    Surely anyone bidding for business would themselves check the criteria on which they would submit their quote. Secondly even if "the government" was in error I would have thought that much of the cost of submitting a new bid would have already been incurred by the bidders in their original "due diligence".

  • rate this
    +6

    Comment number 129.

    Given the squeeze on the government's budgets, how much Political pressure was put on the Civil Service to slavishly choose the biggest bidder? The franchise revenues underwrite the investment made in the railway.

    Remember Nick Clegg and David Cameron relaunched the coalition a few months back, using the Railway investment programme as their centrepiece.

  • rate this
    +17

    Comment number 128.

    Justine Greening - does she really have an MBA, ACA qualification and an economics degree - long term discounted cash flow modelling is in all 3 syllabuses - should be applied to WCML and HS2 modelling - combine this with not knowing about fuel duty changes, and you have to wonder about her competence, but at least she does what DC wants - Int Development safe in her hands? I think not!

  • rate this
    0

    Comment number 127.

    If only we could move away from tribal politics for a brief period, we would see that we are being led by a collective that is in the game for their personal advantage.

    There's nothing shocking about that... it's how it is.

    The irony is that these deluded individuals... by their selfish actions... damage the very system they seek to profit from.

    Not a bad definition of an 'idiot'.

  • rate this
    +1

    Comment number 126.

    I think this reference point, along with the one on finance, gives a marvellous triangulation as to the position with Government competence, or rather lack of it.

    It won't be wasted on a very large part of the electorate.

  • rate this
    +3

    Comment number 125.

    Fiasco hardly describes this nonsense.

    First will no doubt want to re-bid.
    As will Virgin.

    In the light of what has been gleaned of possible operating costs, expenses, that have altered.

    Then there will be cries of foul as one bidder or the other is accused of having access to privileged information.

    I wouldn't be surprised if G4S made a bid..

    Surprised if the obvious nationalisation did...

  • rate this
    +2

    Comment number 124.

    First Group's share price has fallen by over 20% today. That tells you all you need to know about rail franchising.

 

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