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
    +2

    Comment number 116.

    And to think that the civil servants had to hand some of the most sophisticated, powerful, intuitive and dynamic computers available-their brains! Mind you, there have been reports that some of them may have come down with the ABB virus.

  • rate this
    +2

    Comment number 115.

    This just goes to show what most people think anyway. The Public Sector and its employee's are just not up to scratch.
    No wonder they were suspended! A Private Company they would have sacked them, as simple as that. That is why they tend not to make those mistakes in the first place.
    Re-nationalising would bring back these errors ever more with these substandard workers, and carry on wasting it.

  • rate this
    0

    Comment number 114.

    john major was known to favour a return to a system identical to the big 4 created in the grouping of the railways from january 1st 1923 but was overruled by the civil service. i have always thought that if privatisation was necessary that a privatised british railways should have been created as one entity with more control over financing but the danger exists that somebody would try to buy

  • rate this
    +1

    Comment number 113.

    @105.mr_market
    The reason the little boys in UK get no UK work is that the UK government consistently desires to take the foreign 'business' (aka holiday) trips, back handers and other sweeteners. Look at the police - spot the British police car, NHS computers, royal wedding china...... all foreign. SME's are considered likely to fail with a multimillion contract but a large company is a safe bet

  • rate this
    -1

    Comment number 112.

    I can't help but wonder how such a contract would have been awarded say 30 or 40 years ago, prior to all this VfM and RoC and EU tendering regulations, etc., etc.

    Yeah, for sure, probably on an old pal's / old school tie act. But actually would the resultant procurement have been any worse?

  • rate this
    +5

    Comment number 111.

    Try to face facts:

    The WHOLE franchising business is a gigantic waste of taxpayers' money.

    The railways must be re-nationalised and all franchises terminated forthwith. This is the best deal for taxpayers and travellers.

    A rail system needs to incentivise the running of the maximum capacity on the service consistent with travellers need. The present system does not do this.

  • rate this
    +2

    Comment number 110.

    @101
    The last comment harks back to a top gear challenge which all 3 presenters succeeded. For me I have driven Cambridge to Newcastle and back, then repeated a week later as that was cheaper than sending my family by train. A company that owned ALL its infrastructure, stations, trains etc. could set its own fares to be competitive, currently there are too many fingers in the pie

  • rate this
    +3

    Comment number 109.

    "We all seem to be incredibly insightful after something has gone wrong but not before.

    "

    Some of us - and the transport groups and unions - and notably Private Eye - have been saying what a catastrophic waste of public money the privatised rail industry is - for 20 years.

    Tens of billions down the throats of the City later - even the BBC might have noticed

  • rate this
    0

    Comment number 108.

    First Group will sue. Before they put in their bid their Lawyers had already told them that the terms were such that they couldn't fail to make a profit, if not from the passengers then from the taxpayers. The current debacle has removed the passengers from the equation that's all. Doubles all round what?

  • rate this
    +1

    Comment number 107.

    Penny Gaines, of Quainton, chairman of the Stop HS2 campaign group, says: “The Government have now been forced to admit that these projections are completely flawed in relation to the West Coast Main Line." So how can we be sure they are not flawed in relation to HS2?
    Has anyone checked HS2?

  • rate this
    +1

    Comment number 106.

    101

    Thatcher did not privatise the railways: Major did.

    A friend who worked on the privatisation has told me that it was structured to benefit The Treasury.

    Another example of the short-term thinking that so bedevils this country.

    Rail freight is what will make the railways pay not long-distance passengers who have to be subsidised. Strange that rail freight is still seriously under invested.

  • rate this
    0

    Comment number 105.

    Tendering and procurement has long been a minefield for SME's too.

    Opaque, obfuscated, foregone...

    "SMEs only win about two per cent of the public sector's annual £100bn business in the UK, even though SMEs account for more than 50 per cent of Britain's GDP" see article below 2008.

    http://www.director.co.uk/MAGAZINE/2008/3%20March/procurement_61_8.html

    The little boys suck it up, big boys sue

  • rate this
    0

    Comment number 104.

    Hi Robert I listen to many of your broadcasts and reports with great interest. However, it seems easy to say that the whole process was flawed after the event. Why weren't you saying that before - or were you? We all seem to be incredibly insightful after something has gone wrong but not before.

  • rate this
    0

    Comment number 103.

    Cost to taxpayers = £40 million because firms involved in the bids will be reimbursed.DfT Secretary Philip Rutnam said: “The errors exposed by our investigation are deeply concerning. They show a lack of good process & a lack of proper quality assurance…I am determined to identify exactly what went wrong and why, and to put these things right...”
    How will taxpayers know when it's right?

  • rate this
    +3

    Comment number 102.

    59 Wrekin Air
    You will be surprised to know that all road maintenance is undertaken by private contractors even the Motorways.
    Hatfield happened under a government created and directed neo-quango business.
    The air travel industry seems to thrive safely under private enterprise despite the legacy of ghastly post nationalisation unionisation.

  • rate this
    -2

    Comment number 101.

    The problem was created by Thatcher. The railways should either have been split so a new company owned track, stations, signals, trains, timetables, fares for a particular area of the country. Or not (and probably better) privatised at all. Fares need to be pushed down - it can't be right that it is cheaper to BUY, tax, insure, fuel a car to go from London to Manchester than use the train.

  • rate this
    +1

    Comment number 100.

    "Despite his there are still some very good people in the CS". There certainly are, unfortunately the emphasis is probably on "some". There are I fear a larger number who are not as skilled/motivated/competent (to be clear this is central gov CS I'm referring to, not the wider "civilian service roles - police, nurses etc etc".. Something I wish the unions would differentiate as well.

  • rate this
    +1

    Comment number 99.

    NOT FirstGroup's fault. It was errors in department's own model about what would happen to inflation & passenger numbers = "ready reckoner" was wrong. Dept'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.
    In other words shoddy.
    What's new?

  • rate this
    0

    Comment number 98.

    Re. 95 & 91 (& others): The main reason that rail was privatised was because the Govt couldn't afford the massive capital investment required to repair decades of neglect.

    So we're in a better position now?

  • rate this
    +2

    Comment number 97.

    90.Chelseaboy

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

    Oh, I don't know: they brought about an extra million seats into circulation with the May 2011 timetable, jazzed up Wakefield and Peterborough stations and hardly wasted any money repainting the trains!

 

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