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• 1. Industry Structure under Franchising
• 2. The Benefits and Costs of Privatization

APPENDIX B
Passenger Rail Franchising in Great Britain

A White Paper published in July 1992 explained how British Rail would be split into more than 100 separate companies, with the rail infrastructure kept separate from rolling stock companies (ROSCOs) and passenger and freight operations. Passenger rail would further be divided into 25 Train Operating Units (TOUs), plus a European Passenger Service (EPS). Freight operations would be split into 5 companies, while infrastructure maintenance operations would be organized into 14 Infrastructure Service Units (ISUs). This vertically separated structure was specifically devised so that the government could shift the revenue and debt risks of British Rail to the private sector and hopefully unleash the competitive private zeal and ingenuity necessary to rejuvenate a mature industry.

1. Industry Structure under Franchising

This privatization initiative began in earnest in November 1993 with the passage of the Railway Act and the establishment of the Office of Passenger Rail Franchising (OPRAF). OPRAF is an independent standalone department headed by the Franchise Director. The Transport Minister can issue instructions or direct the Franchise Director only within a statutory framework; day-to-day decision-making rests with the Franchise Director. OPRAF was given two key tasks: (1) the immediate priority of selling 25 regional, commuter and intercity passenger rail businesses; and (2) the ongoing responsibility of funding, contractually managing and promoting investment within these businesses once sold.

The contractual structure of a franchise agreement is rather complicated, with many conditions providing little room for variance. The key criteria of a franchise agreement are: (1) Service Levels: Passenger Services Requirements set out the minimum level and pattern of services (i.e. frequency, first and last train, journey times and intermediate stops); (2) Payments: the subsidy (premium) payable to the operator (government); (3) Term: the duration of the franchise; (4) Network Benefits: the operator is required to participate in network schemes (i.e. through-ticketing, multimodal travelcards, national telephone enquiry); (5) Fares: the Franchise Director regulates a wide range of fares; (6) Incentive Regime: financial incentives in the form of cash rewards/penalties are designed to encourage better performance and discourage poor performance as defined in franchise contract, including the control of overcrowding; and (7) Financial and Corporate Safeguards: financial commitments, including the provision of share capital and a performance bond, must be made.

The Franchise Director was given two key objectives in letting a franchise: (1) secure value for money; and (2) encourage railway development. He carried out these objectives between December 1995 and February 1997 and there are now 13 operators holding 25 franchises that have become known as Train Operating Companies (TOCs). TOCs do not own the trains they use; they lease them from the ROSCOs. Indeed, TOCs are very much restricted to being rail service companies as they do not have significant asset holdings.

FIGURE 1

There are three ROSCOs - Porterbrook, Eversholt and Angel - that were privatized in 1995; two were subsequently resold, with one being purchased by a major TOC. This is probably the weakest link in the vertically separated rail industry structure as these companies can be squeezed out of their leasing role by other lessor companies in combination with rolling stock manufacturers, particularly as the passenger services industry moves away from specialized train sets to universal train sets.

Railtrack, owner of the railway infrastructure, was privatized in 1996 for £1.95 billion. Railtrack now earns 95% of its annual revenues of £2.4 billion from renting out space at stations and by providing access to tracks to TOCs and Freight Operating Companies (FOCs). Currently, it has a market capitalization of £3.5 billion. Finally, British Rail's freight operation was privatized in February 1996 to an American-based company, Wisconsin Central, and operates what has become known as English, Welsh & Scottish Railway.

The Railway Act of 1993 also established the Office of the Rail Regulator to promote the public interest objectives set out in that statute. The Rail Regulator heads an independent non-Ministerial Department for a fixed term and is guided by British Administrative Law. See Figure 1 for a diagrammatic representation of the British railway industrial structure.

2. The Benefits and Costs of Privatization

As mentioned above, the privatization initiative was adopted by the government to shift the revenue and debt risks of British Rail to the private sector. While it is still too early to tell and notwithstanding mixed opinions on its success, it appears that under the privatized system, as performance indicators for 63 service groupings suggest, passenger rail services are better. These indicators demonstrate:

Source: OPRAF, Annual Report 1996-97, p. 12.

Not surprisingly, demand for passenger rail services is up substantially, but how much is attributable to the better combination of services and fares and how much is due to the improved national economy is unclear.

The privatization process raised approximately £5 billion in proceeds from the disposition of its rail assets to private interests, including:

It also left the government with approximately £1.7 billion in debt that had to be written off.1 At the same time, OPRAF forecasts annual subsidies declining from their peak of £2.1 billion in 1996-97 to £926 million in 2002-03. Given that the subsidy paid to British Rail in the last year of its operation was about £1 billion and the ongoing operating costs of the Rail Regulator, OPRAF and the Department of Transport total £100 million, the increase in annual subsidies paid to the newly privatized sector over the first franchise term comes to about £5 billion. The government can, therefore, claim a cash savings in the first franchise period equal to the expected investment level of private operators totalling £3.5 billion, broken down as follows:

minus the £1.7 billion debt write-offs and other start-up costs of the new regime.

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1 This is not abnormal when privatizations occur. The favourable debt rating provided by the government invariably leads the Crown corporation to rely more heavily upon debt relative to equity. The debt write-offs make the flotation of such shares more palatable to private investors and is, therefore, in the taxpayers' best interest.