Ensuring Value for Money from Rail Franchise Margins
Andrew Meaney, Oxera Consulting Ltd, Christopher Davis, Oxera Consulting Ltd, Lewis Gudgeon, Oxera Consulting Ltd
Client bodies have considerable influence over the margin required by operators—this paper describes the forms of this influence, and how using it wisely can improve value for money.
Passenger rail operators require a margin (compensation) for providing rail services to passengers, under contract from public authorities. This margin represents a reward for the risk being transferred from the client body to the railway undertaking. Importantly, the form of the contract can have a considerable effect on the margin required by the operator. If the operator is exposed to considerable risk under the contract, the margin will be high; conversely, a management contract will attract a low required margin.
While these basic principles tend to be well understood, the link between contract design, the payment of the margin and value for money is, perhaps, not so often explored. This paper describes a framework that public authorities can use to design passenger rail contracts such that the margin required by railway undertakings offers value for money to taxpayers and shareholders.
The framework follows these steps:
1. Ensure that the agreement with the railway undertaking reflects policy objectives—what is the tender or direct award meant to achieve?
2. Find ways in which the contract also aligns incentives between the railway undertaking and the infrastructure manager. Does the contract enable the passenger operator to benefit from improvements in the efficiency of the network operator?
3. Balance risk transfer such that the operator has limited exposure to events that are outside its control, which the public authority can reasonably retain risk for. For example, transfer volume risk, but include mechanisms to limit this to areas that the railway undertaking can influence.
4. Reflecting step 1, require that the contract includes incentives for efficiency, innovation and service quality improvements. The operator may improve its outturn margin if it delivers against these objectives.
The framework enables public authorities to demonstrate that the margin they are paying not only complies with relevant legislation, but also delivers value for money. It should avoid excessive risk transfer, and enable incentive alignment.
To illustrate the framework, the paper presents evidence on margins obtained by passenger rail operators in Europe, and shows how the European Commission has assessed margins in the context of Regulation 1370/2007 (which provides rules for passenger transport contracting by public authorities), in both guidance on application of the Regulation and its decision practice.
Association for European Transport