A passenger rail franchise was a contract between government and a train operator, to run services on specified routes, calling at named stations, using specified rolling stock and observing a minimum timetable, for an agreed period.
The costs of doing this were never neutral, and a particular franchise would either return a profit or run at a loss.
Premiums
If the franchise was expected to run at a profit, then government wanted a share of the returns, known as premiums. The operator was expected to pay the premiums due under the contract to the Department for Transport at regular intervals. Failure to do so would have been a breach of contract, and could be followed by termination.
Subsidies
If the specified services would cost more to provide than they could earn in fares, then the franchise attracted subsidies. These were paid by the Department for Transport to the operator, again at agreed intervals..
Franchise competitions
Would-be operators competed for each franchise when it was advertised. The usual process was (1) An general invitation for interested parties to make themselves known, followed by (2) the identification of prequalified bidders (usually at least three) and (3) a formal Invitation to Tender. Prospective franchisees responding to an ITT were then given access to confidential information (in the ‘Data Room’) about the economics of the franchise concerned so that they could draw up realistic ‘best and final’ offers.
Stage (4) was usually the announcement of a preferred bidder, followed by final negotiations. If all was well, Stage (5) was the handover itself. The date of the handover was usually known from the start, because it was the day that the previous contract ended. The precise transfer of control was customarily at 02.00 on the handover day, when traffic levels are at their lowest and in some cases no trains are moving at all.
Profiles
The scale of payments, one way or the other, was set out in the franchise profile, which was theoretically published but rarely highlighted in detail nor always readily traceable in official sources after the event. A profile might not have consisted entirely of premiums or subsidies. Some franchise profiles started with subsidy but moved into premium in the later years of the contract.
Cap and collar
Although a franchisee took significant commercial risk (and some failed) there was a level of protection in later contracts, known as the cap and collar clause. If revenue exceeded a certain amount, the government could claim some of this as an additional profit share (the cap): on the other hand, if revenue was lower than expected, even though the franchisee had run the specified service to agreed performance criteria, then the government could make good some of the shortfall (the collar). Although each contract stood alone, typical values either way were as much as 80%, and the cap and collar arrangements normally became ’live’ in Year 4. Therefore, in the early years, the franchisee could keep all additional profits but also bore a greater commercial risk. In early 2011 the government abandoned the cap and collar clauses in future contracts, substituting a simple profit share provision in the event of higher than expected revenue. In other words, this retained the cap but excluded the collar.
How cap and collar worked
For example, if after four years revenue fell between 98% and 94% of the target set out in the franchise contract, then the DfT would pay 50% of the shortfall to the franchisee. If it fell below 94%, then the DfT paid 80% of the further shortfall. However, if actual revenue was between 102% and 106% of the target, then 50% of the excess between 102% and 106% was shared with the DfT. If it went above 106%, then 80% of the further excess was payable to the DfT. (These were typical figures, and could vary.)
Who won the franchise?
The Department for Transport did not necessarily simply accept the best bid, that is, one which promised the highest premium or claimed the lowest subsidy. All bids were subjected to a ‘deliverability’ test during the later part of Stage (3) above, and exceptionally optimistic offers were likely to be eliminated.
.
