Why all the West Coast bids were wrong

 
trains

I have learned a bit more about the mistakes made by the Department for Transport in overseeing the contest to win West Coast Main Line rail franchise.

As I understand it, the entire bidding process was flawed - and that all four of the bidders were given erroneous information by civil servants when preparing their bids.

The nature of the mistake, which I describe below, carries all sorts of implications.

One consequence is that all the bidders were offering far too little protection to taxpayers against the risks of collapse by a franchise holder. In other words, if the mistake had not been picked up, taxpayers would have been excessively exposed to potential losses at some point during the 15-year life of the franchise.

The nature of the department's errors, with all the bidders given flawed data, explains why the Department for Transport has said that it cannot be certain that the outcome of the bidding process would have been different if the process had been robust. In other words, FirstGroup might still have won.

That might make FirstGroup marginally less hostile to the idea that Virgin may be asked to keep running the service for an additional 18 months to two years, until a new tendering process can be completed and the new franchise holder can be in place - because there is no evidence that Virgin as the incumbent would have had an advantage if the last contest had been run properly.

A decision on whether the franchise will stay with Virgin for an interim period, or go into temporary public ownership, will be taken in the next few days.

That said, FirstGroup is considering suing the government for substantial damages resulting from the way it was first awarded and then stripped of the franchise. As it happens, those close to a number of the failed bidders tell me they expect the compensation payments from taxpayers to run to hundreds of millions of pounds, far more than the £40m that has been widely reported.

I am told that ministers and officials are desperately anxious to somehow dissuade FirstGroup from suing, although it is not clear why it would be in the interests of FirstGroup's shareholders to settle without the threat of legal action.

Robert Peston: "I think it does have actually quite big implications for taxpayers"

But back to what went wrong. All this is slightly technical and complicated, so bear with me.

When there are contests to award complicated long-term contracts such as this one, civil servants construct their own financial model. This contains certain assumptions about what is likely to happen to important economic variables, such as inflation and passenger numbers, over the contract period.

The model serves two purposes.

It helps civil servants and ministers evaluate bids against their own benchmarks, when those bids are submitted.

But perhaps more importantly, it helps the bidders to submit bids on a basis that allows them to be compared. It creates a level playing field for the bidders.

What happens is that the model produces what is known as a "ready reckoner" which is given to the bidders. This ready reckoner tells each bidder the financial implications of their respective forecasts of how much they think they can increase revenues.

In particular, it tells a bidder how much capital its so-called Train Operating Company (TOC) would have to hold as a protection for taxpayers against the risk that in the course of operating the franchise the TOC went bust or risked going bust.

The point is that any bidder could submit wildly optimistic and unrealistic forecasts for how much its TOC could increase its revenues in order to win the bid, and then get into lethal financial difficulties when actually operating the franchise on that basis.

So to minimise that risk, all the bidders are told that they have to endow the TOC with sufficient capital to protect taxpayers from potential losses.

In the case of FirstGroup, for example, its winning bid endowed its new TOC with £10m of capital from day one, and there was also a £190m subordinated loan from FirstGroup to the TOC and a £45m "performance bond".

All of which may sound like a fair amount of money to absorb the costs of an abrupt termination of the franchise.

But what the Department for Transport discovered in the last few days is that the capital protection being offered was far too little. That was not FirstGroup's fault. It was because of assumptions in the department's own model about what would happen to inflation and passenger numbers - which in turn meant that the ready reckoner given to bidders was wrong.

In fact, the department's mistakes meant that all the bids were offering far too little protection to taxpayers against the possibility of a franchise holder being unable to hold the franchise for the full 15 years.

The implications are serious for the whole process of tendering for rail franchises. It explains why the department has suspended the competitions to run the Great Western, Essex Thameside and Thameslink services, just in case the financial models underpinning those contests are flawed in a similar way.

One very interesting question is how much extra capital First Group and the other bidders would have been forced to hold if the department's model and ready reckoner had been correct.

Here is the big point. It is very expensive for companies to raise capital. It is theoretically possible that FirstGroup - or indeed any of the four bidders - would not have been able to afford the correct amount of capital.

That raises a further question - whether the government will have to revert to awarding eight-year franchises, rather than 15-year franchises, because in theory the capital required to underpin an eight-year contract should be much less.

UPDATE 16:50

Here is a tidbit which will add to the government's misery over the West Coast rail debacle.

Virgin tells me that they received the erroneous data from the Department for Transport's flawed ready reckoner and concluded that it was wrong - so they ignored it when submitting their own bid.

The current West Coast encumbent even went so far as to tell the Department for Transport that its numbers were awry.

But apparently the Department ignored Virgin and pressed ahead with the bidding contest.

For what it's worth, Virgin insists that the bid it submitted has a robust financial basis - and it believes it would have submitted the same bid, even if the department had got its own numbers correct.

On the other issue, of whether Virgin will continue to run the franchise for the two years before a new contact can come into force, or whether the West Coast line will go into temporary public ownership, my sense from talking to sources in government and among the bidders is that Virgin will prevail.

The main reason is that there are 150 West Coast contracts that are up for renewal between now and 9 December, when Virgin's current tenure expires. It would be quite a challenge for civil servants, with only a cursory knowledge of the business, to suddenly take over responsibility for those contracts.

 
Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this
    -1

    Comment number 96.

    @83 Option 3 is quite likely to be true. The Govt are expecting civil servants to do the work they previously would have bought in experts to do. Whatever people think about CS pay it doesn't normally match the pay you can get in the private sector, so the best people tend to go into the private sector. Despite his there are still some very good people in the CS

  • rate this
    -1

    Comment number 95.

    89.langstroth - "......If it's nationalised tax payers will pick up the bill anyway......."


    The nationalised system was cheaper.....therefore it cost less than the current messy privatisation system does (billions less) because no one is taking profit out of it.

    That's why it should be nationlised, because we pick up the extra large tab for private greed & incompetance as things stand.....

  • rate this
    +1

    Comment number 94.

    Perhaps we should employ Swiss managers to run our railways .

    I wonder if they use the same models when telling us expected passenger numbers for Heathrow, Crossrail. Hs2 et al

    did we get value out of the last WCML upgrade ? Was the HS1 sale really value for money ? i very much doubt it now....

  • rate this
    0

    Comment number 93.

    86

    Airlines are protected from taxation by international treaties and some shipping lines are funded by soft government loans.

    The cost of all the freight and passenger infrastructure is huge and the investments have to be long term.

    I can't keep the image of a Routemaster out of my head: a brilliant concept done to death by government and commerce acting together in their own interests.

  • rate this
    +3

    Comment number 92.

    All 4 bidders were given erroneous information by civil servants when preparing their bids. Consequence: bidders were offering far too little protection to taxpayers against the risks of collapse by a franchise holder. If the mistake had not been picked up, taxpayers would have been excessively exposed to potential losses...
    In other words: carelessness.
    What's new?

  • rate this
    +1

    Comment number 91.

    "errr, don't get your logic. If it's nationalised tax payers will pick up the bill anyway."

    Well on purely cost grounds, lets renationalise it because the costs to the taxpayer and to the economy have skyrocketed for a far worse service.

    I would have thought that was a really simple one. Lets have a smaller bill

    Of course the City won't skim so much so plenty on here will squeal furiously

  • rate this
    +1

    Comment number 90.

    All those advocating bringing the WCML into public control are forgetting that the government cannot even run a tendering process for the railway, let alone run it. Leave it to Virgin on an interim basis who by all accounts have done a good job up to now.

    The ECML is muddling along without any major investment, its hardly a great advert for public ownership of the railways.

  • rate this
    +1

    Comment number 89.

    "Firstly why don't we just run our own railway like other countries and basically nationalise it. After all when it goes wrong currently the taxpayer picks up the bill?!"
    errr, don't get your logic. If it's nationalised tax payers will pick up the bill anyway. Nationalisation always leads to political interference, treasury led blocking of spending and poor management by civil servants...

  • rate this
    +1

    Comment number 88.

    The flaws carry a potentially serious consequence for the public. Reducing that risk must be good. However the bigger picture questions whether this hybrid public/private model can be controlled to the advantage of the population. The track record of privatised utilities and the readiness with which the giant rail companies had recourse to law and millions in compensation if baulked suggests not.

  • rate this
    0

    Comment number 87.

    Civil servants are easy scapegoats who can't reply.

    What is wrong is an entire model of organisation. I never understood rail privatisation and it is now evident that British Rail did not have enough money to develop.

    Railways should be run by trained railway-people and if a view is taken that civil servants need to supervise contracts then they too should be trained in the necessary skills.

  • rate this
    -3

    Comment number 86.

    # 78 - what is unique about rail transport that it should be run on a not for profit basis? Airlines, shipping, buses, taxis are all operated on a commercial basis.

  • rate this
    0

    Comment number 85.

    Surely the bidders have their own models and assumptions? There is no level playing field. The ready reckoner is a dumbed down version of the DfT model.Why not have all bidders to use the DfT model in their bids? It is good you have found a source willing to confirm that DfT made mistakes but you seem to have swallowed what they told you hook, line and sinker. Robert you need to do more analysis.

  • rate this
    +1

    Comment number 84.

    A Realist: "The Civil Servants who put the West Coast Main Line tender together, where either:

    1) Incompetant. (Fools who had risen up through the ranks into positions of influence)

    2) Fraudsters with deliberate plan to defraud the taxpayer using "pretend incompetance"


    Or - consultants on secondment from the City. Its a RACKET. This time they all got caught

    PS Try spellchecker

  • rate this
    +2

    Comment number 83.

    76.A Realist


    You forgot option 3:

    They were very hard working, dedicated public servants, tyring to do the best job they could, but were asked by a Govt Minister to undertake a role that was beyond their capabilities......& should have been given to a Procurement expert - though Govt won't hire them because us, the public, would moan about the cost, even though it would save us money.....

  • rate this
    +1

    Comment number 82.

    the problem with short franchises is that they do not encourage the franchise holder to invest. a typical british attitude of not thinking beyond the end of their noses.
    the idea of longer franchises is sensible to encourage more investment. look at chiltern with 20 year franchise which has more sensible
    fares policy and competes with virgin from brum to london. no need for a bank loan.

  • rate this
    0

    Comment number 81.

    The West-coast railway franchise mess seems to be an expensive one that tax payers appear to have to foot the bill. However I would thought that whoever wins next round that they are refunded at end of franchise term by a reduction in what they pay to the government. The losers get a fixed sum back not the whole lot of bidding expense

  • rate this
    +5

    Comment number 80.

    Don't forget Virgin knew the bid system was flawed and had a 13 year track record of getting it right despite this.

    Credit where it's due please Robert!

  • rate this
    +5

    Comment number 79.

    GO needs to get money coming in to Treasury NOW & reduce his payments out. He needs lower unemployment for the latter. 0% CGT for worker share participation doesn't help.

    He needs to tackle inflation - not by fiddling CPI/RPI down or up or sideways - but by actually reducing costs for businesses, families & individuals.

  • rate this
    +7

    Comment number 78.

    The railway trains should be run by Railway Companies not bus companies. The Infrastructure and trains should be coordinated. There is no way on earth of making a straight profit from Railways the peak fails to subsidise the off-peak so govt has to subsidise the difference in costs. This economics is the same now as fifty years ago.

    Run it as a not-for-profit with railway people managing it.

  • rate this
    +3

    Comment number 77.

    It's inevitable Civil Servants "run" the country as unlike governments they are there for the long term not for the length of a parliament or reign of a minister.This is why we need to have the best (and probably most expensive) incumbants in senior roles.Cut price officials cost more money, not less.
    Perhaps the Government should look at its policies in regard to hiring.

 

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