Why Virgin and First Group should both be allowed to run trains on the West Coast Mainline

October 8, 2012

This week the saga of the West Coast Mainline franchise descended into farce, as the Government admitted serious errors in assessment of bids, cancelled the current tendering process and will need to pay bidders millions in compensation. But the resulting delay to deciding any further rail franchises gives time to reconsider whether monopoly franchises are the best way to secure high-performing and efficient trains.

The current rail franchising arrangements enable a single decision-maker – the Government – to allocate the right to a substantial monopoly – in the case of the West Coast Mainline, a 13 year exclusive contract on a route that carries 13 million passengers every year.   This has a number of problems.

The decision reflects the political priorities of the moment, and not necessarily the long-term interests of passengers and the economy.  There were accusations, in the abortive West Coast Mainline decision, that the Government prioritised maximising revenues to the Treasury over other considerations.

There is a huge premium on the competence of the decision-maker.  Even before this week’s debacle, the Government had a poor track record in writing effective contracts, allowing previous East Coast Mainline franchisees to walk away without adequate penalty.

And political lobbyists and lawyers play a central role in trying to capture the available rents in the monopoly allocation process.  The West Coast Mainline process played out in the media (where the relative merits of Virgin and First Group were debated and an online petition attracted tens of thousands of signatures), in the courts, and in party political point-scoring.

Things do not have to be done this way.  A monopoly franchise does not have to be granted one train operator.  The West Coast Mainline – like a number of other of the major passenger services – is profitable, unsubsidised.  Companies should be allowed to operate trains in direct ‘on-rail’ competition for passengers on the same route – on the basis of their prices and services.  Passengers would decide which companies operated on the West Coast Mainline, not politicians, lawyers, lobbyists or the media.  Not all passengers would actively exercise choice, but only a proportion need do so to exert a powerful incentive on train operators.

There is already some competition on the railways, but it is heavily constrained because 90% of network capacity is taken up by franchised services under exclusive contract to the Government.  Only Virgin is allowed to operate fast, long-distance trains on the West Coast Mainline.  Where a few companies, such as Hull Trains, have come in to compete on some lines – through ‘open access’– they are tightly restricted so that they do not threaten the revenues of the monopoly franchisees.  So open access passenger services account for less than 1% of all timetabled train miles.

The Office of Rail Regulation (ORR) has found that, where it exists, open access competition brings passenger benefits through lower fares and higher growth in passenger numbers.  It argues that where train operators need to win or retain passengers in the face of competition, this puts them under pressure to keep costs down and to better respond to passengers’ needs, which may stimulate service innovation.  The ORR commissioned modelling of the East Coast Mainline, which showed that increasing on-rail competition could bring benefits to passengers that would significantly outweigh the cost to government.  Greater on-rail competition could be achieved through creating more overlapping franchises, and by reducing the number of services covered by franchises leaving more for open access.

However, the Department for Transport opposes expansion of on-rail competition.  In a letter to the ORR, the Department made clear that “although an increase in on-rail competition might deliver passenger benefits … such a move would give rise to a greater call on public funds.”  In other words, the Government is keen to hold onto its share of the monopoly ‘economic rents’ from profitable franchised routes.  It does not wish to see competition drive prices down to passengers, because it could reduce revenues to the Treasury.  So the current government is following in the footsteps Labour that, in 2002, consolidated franchises, removing overlaps in order to eliminate existing competition between franchises, and thus raise more money for the Government.

Of course, the Treasury needs to raise revenues.  But it is a very poor type of tax that requires the maintenance of an industry monopoly, forgoing the benefits of choice and innovation.  And in fact, the ORR has proposed a less damaging way of shoring up Government revenues consistent with more competition (through a system of auctions for using rail network capacity).

The reviews following this week’s events are an opportunity for the Government to develop a different approach to the West and East Coast Mainlines – one that would benefit passengers and the economy more widely.

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