New Thinking, New Insight

Mind the Gap: West coast rail franchise risk management fiasco

Whitehall was burning the midnight oil late last night because at one minute past twelve the government chose to announce “technical flaws” had been discovered in the award of the franchise to FirstGroup and turned out the lights on the 15-months bid process in what is surely a humiliating and costly U-turn.  The Department for Transport has suspended three staff for ‘unacceptable mistakes’ and bidding on other rail franchises in Britain has also been suspended.  According to the Financial Times, the cancellation will cost at least £40m but this could soar to hundreds of millions of pounds if FirstGroup takes legal action, other rail companies claim compensation and future bidders are less aggressive, meaning revenues would be lower.

Virgin claimed in August when it launched its legal action that its rival’s bid skewed payments to the government toward the back end of the 15-year-contract.  It seems possible that officials failed to carry out correctly a proper discounted cash-flow analysis. Failure to convert FirstGroup’s significant back-end-loaded payments into net present values could have resulted in the value of its bid being inflated relative to that by Virgin Trains.

Moreover, Virgin had claimed that FirstGroup could have been able to walk away from its contract before those larger payments started to become due, allowing it to operate the rail franchise for many years at little cost to itself and reduced benefit to taxpayers.

The implications are considerable, because the DfT’s admission puts the 2013 franchising programme in jeopardy. Four franchises were due to be renewed next year – Essex Thameside (currently c2c), Greater Western, Thameslink and East Coast, but the letting processes are now suspended.

And it is not yet clear who will be running intercity services on West Coast from 9 December. The DfT could take over, using its subsidiary Directly Operated Railways, or ask Virgin to carry on for the time being.


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