Rail 2020

Written evidence from Bluespace Thinking Ltd (ROR 03)

COST STRUCTURE – MARCH 2010

1 Summary

1.1 Total 2010/11 UK franchised rail fares revenue was £6.7 Billion, government support was £3.7 Bn. Network Rail spent £5.7 billion of the £10.4 Bn total and the 19 Franchised Train Operating Companies (TOCs) account for £4.7 Bn expenditure net of franchise charges and access costs (payments and receipts from Government or Network Rail) .

1.2 In this paper we show how this money is spent and highlight opportunities for cost reduction. We conclude "structural issues’ in the industry will limit the ability to make the efficiency improvements identified by the McNulty report.

2 Overall cost structure

2.1 It is mot possible to fully detail how this money is spent but from Network Rail accounts, accounts from some TOCs and information available via the Office of Rail Regulator and from DfT investment business cases it is possible to provide a reasonable estimate of the break down. Our methodology is to reconcile the cost base to the revenue figures in annual accounts. Figure 1 shows the expenditure breakdown.

Figure 1 Overall expenditure breakdown
Network Rail	2011	2010
Financing cost & derivatives losses	£1.68	£1.67
Staff costs	£1.73	£1.75
Contractors costs (track maintenance and upgrade)	£1.60	£1.73
Other operating losses (income)	£0.25	£0.25
Corporation Tax	£0.13	£0.11
Retained for future investment	£0.32	£0.11
Network Rail total revenue/expenditure	£5.71	£5.62
TOCs Group	2011 Mid range
Rolling Stock base cost	£0.90
Rolling Stock lease financing premium	£0.60
Staff costs	£1.35
Power costs	£0.35
Other costs	£0.80
Other operating losses/ (income)	£0.40
Corporation Tax	£0.10
Dividends (To shareholders)	£0.20
TOCs group revenue/expenditure net of franchise costs, subsidy & track access cost.	£4.70
Total summary	2011
Total true operating costs	£6.74	65%
Finance costs	£2.28	22%
Operating losses undefined	£0.65	6%
Retained for future investment	£0.32	3%
Tax	£0.23	2%
Dividends	£0.20	2%
Total	£10.41	100%

3. Financing Costs

3.1 Financing costs (£2.28 Bn 22% of all costs) are a major source of disparity between UK rail and other European networks. Network Rail have £26 Bn of government guaranteed debt on which they paid 5.8% average interest in 2011. Also over the last two years they have lost £0.7 Bn on financial derivatives presumably bought for risk management purposes.

3.2 Because of the franchise system TOCs tend to lease rolling stock for relatively short periods of time. A combination of lease finance and the risk associated with short contract periods add a significant premium to the base rolling stock cost.

3.3 In the evaluation of major new projects the DfT assume that Government will provide the infrastructure and rolling stock capital; interest and lease charges are not taken into account. Where commercial finance is used out turns will clearly not meet original project expectations. Alternative ways of providing Government finance could reduce finance cost significantly but would appear as Government debt in the National accounts.

4. Rolling stock costs

4.1 The manufacture of rolling stock is a competitive international business, purchase costs for a given train specification are similar across Europe. However cost per passenger km varies significantly based on the specification (capacity & speed) and utilisation. UK average passengers/train ranges from 240 on the East Coast Mainline to 46 for Northern Rail Ltd at this lower level of passengers it is not possible to run a rail franchise without considerable subsidy.

4.2 After removal of lease financing premium just £0.9 Bn (9% of all costs) is spent on rolling stock.

4.3 Because of the way value of time is treated in the DfT evaluation method four short trains per hour will appear to have greater social benefit than two longer trains with greater capacity or utilization. However when cost /passenger km is looked at the more frequent, lower capacity, trains are much more expensive to purchase and operate. The DfT analysis approach leads directly to higher fares and greater subsidy than in Europe.

4.4 Zurich and Liverpool provide an interesting comparison. Both have similar urban area populations and regional catchment areas In 2008 SBB ordered 50 six-car double-deck electric trains with capacity for 1694 passengers (526 seated) and a top speed of 100mph for Zurich commuter and regional services. In contrast the average age of Merseyside rail’s rolling stock is 32 years and each train carries on average 89 passengers.

4.5 Switzerland has on average 124 passengers/train the UK has 110. Swiss rail subsidy is 28% versus the UK’s 37%. Average Swiss fares are 11.1 p/km versus the UK’s 12.4 p/km. Newer trains result in less breakdowns and a more efficient service.

4.6 The UKs emphasis on track and infrastructure expenditure, the form of franchise contracts and investment evaluation methodology means that current rolling stock is not able to provide effective and efficient rail services in many franchises.

5. 5taff costs

5.1 Combined Network Rail, TOCs, contractor and other staff costs total about £4 billion (40% of all costs). UK average salaries are about 10% higher than in Europe, based on DfT Webtag projections salaries are predicted to increase by 50% in real terms over the next 20 years.

5.2 This means that over the same time period staffing levels would need to be reduced by 55% if the McNulty report’s proposed 35% reduction in costs in real terms is to occur and be maintained by reduced staffing.

5.3 While there maybe scope for reduced staffing through improved working practices this level of absolute reduction is not realistic, the UK appears to have similar staffing levels / passenger km as Switzerland. However by rolling stock changes (higher capacity trains), higher utilisation and passenger numbers it maybe possible to make reductions in staffing cost per passenger km or at least offset the real increase in salaries to hold fares and subsidy level in real terms.

6. Other costs and other income/(losses).

Network Rail and TOCs accounts do not indentify the reason for other costs and charges, however it is probable that part of the other cost category is attributable to contracted services; transport police and national ticketing & enquiry services are mentioned in some accounts. We have assumed that 50% of these costs are salary related and are included in our discussion on staff costs.

6.1 The other income/losses category reported in the accounts is equally opaque but maybe of more concern, both Network rail and some TOCs report "other losses" and the £0.4 Bn figure in the table assumes this level of losses across all the TOCs .

6.2 These "other" categories at 12% of all costs (charges) is more than the cost of rolling stock (ex financing costs), twice the cost of power and 5 times the combined cost of corporation tax and dividends. Further investigation by the TSC may explain these costs & losses and establish if it they are reasonable and if they can be reduced to achieve the 35% McNulty target.

6.3 When evaluating major new rail networks it would appear that the DfT do not include an allowance for this "other" category of cost/charge in their economic evaluation.

7. Electricity, Corporation Tax, Dividends, Board costs and Pension deficits

7.1 These costs all seem in line with the size and structure of the industry, they will hopefully decline in relation to the cost reduction in other areas. Having 19 relatively small TOCs, although owned by just 5 parent companies, will raise Board costs and other costs where scale of operation would spread the cost. Concerns about individual salaries or bonus payments appear unfounded.

7.2 We have noted however that Pension funds are generally under funded by about £1 Bn in total, at some point this money will need to come from fares or subsidy.

8. Conclusions

8.1 The Government’s Command paper talks about changes in Franchise arrangements, organisational structures and vertical integration to reduce costs and improve efficiency.

8.2 To make any real difference there needs to be higher capacity and fuller trains. This may be achievable from investment in rolling stock, platform lengthening and making rail a more attractive alternative with competitive fares and better services.

8.3 In our view it is the Government’s own methodology for the evaluation of investment and the way the subsidised industry is funded that cause the biggest impediments to making the UK rail network efficient. Our second paper "Planning assumptions" explains how inaccuracies in demand forecasting are causing over investment in some areas and a lack of investment in commuter and regional services.

4 April 2012

References

Office of Rail Regulator Statistics 2010/2011

Network Rail Accounts 2011

Various Train operating Company accounts and other data

Swiss Railways SBB Facts and Figure 2011