Biggest threat to rail franchising system: lack of TOC profits?

mrmartin

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It seems to me, despite the more left leaning brigade, that the biggest threat to the current TOC model is the complete lack of profits (or in many cases, horrendous losses).

I haven't seen a TOC deliver more than 3-5% return on capital, which is dreadful considering most private companies deliver anywhere between 10-50% depending on the sector. If you combine this with the massive losses that are easy to make (because of delayed infrastructure and other stuff out of the TOCs hands), this is a fools game.

We've already seen a collapse in the number of bidders for future TOCs. I genuinely wouldn't be surprised if there are 0 or just 1 bidder in future, which makes a mockery of the whole process.

Could it be, ironically, that privatised trains are so hard to make money out of that the whole thing grinds to a halt. This, of course, wouldn't be without precedent, as the original rail system from Victorian times until nationalisation was pretty spectacularly unprofitable.
 
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Bromley boy

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Could it be, ironically, that privatised trains are so hard to make money out of that the whole thing grinds to a halt. This, of course, wouldn't be without precedent, as the original rail system from Victorian times until nationalisation was pretty spectacularly unprofitable.
The answer to this question is a resounding “yes”! TOCs tend not to be too profitable. The margins are low - the 3-5% figure you mention is accurate and reflects what many supermarkets/retailers might earn. Enormous turnover but a low profit. The definition of busy fools.

The post victorian railway has historically been a difficult business to make profits from. Monopolistic competition, which TOCs now enjoy, would in theory be an ideal scenario for TOCs to run relatively few trains during peak hours, at a price which fills the train (or just under) but leaves the majority unable to afford. Down tools off peak.

Of course public service franchise obligations, union derived obligations towards staff, all underpinned by the reality that the railway provides a vital public service prevents this.

EDIT: the reason it won’t ever be allowed to grind to a halt is the enormous economic externalities that would result. The South East of England and London would cease to function, for one.
 
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HSTEd

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I haven't seen a TOC deliver more than 3-5% return on capital, which is dreadful considering most private companies deliver anywhere between 10-50% depending on the sector. If you combine this with the massive losses that are easy to make (because of delayed infrastructure and other stuff out of the TOCs hands), this is a fools game.
I've never seen any return on capital figures myself. All I've seen is profits as a function of turnover, and that is something totally different.

How much capital do you actually need to win a franchise?
 

DPWH

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Profit isn't everything. A rail company is highly likely to make small profits over a period of time, whereas other sectors can be more volatile.
 

LNW-GW Joint

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And yet the number of companies with passports to bid for a franchise keeps increasing (most recently RENFE, NTV and Transdev).
Trenitalia is a recent newcomer as a franchisee and is bidding for more.
It's the older set who have run into trouble.
 

daikilo

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I've never seen any return on capital figures myself. All I've seen is profits as a function of turnover, and that is something totally different.

How much capital do you actually need to win a franchise?
Indeed, the question includes the wrong terms. A bidder to operate a TOC will have to provide one or more bonds which could be seen as investments or operating expense depending on how they are financed. Everything else is operating expense. As far as shareholders of the companies and parent companies are concerned, they will only be unhappy if they fail to receive the dividends they had expected and possibly alreadyy allocated to other ventures.
 

Robertj21a

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And yet the number of companies with passports to bid for a franchise keeps increasing (most recently RENFE, NTV and Transdev).
Trenitalia is a recent newcomer as a franchisee and is bidding for more.
It's the older set who have run into trouble.
Suggesting that the old ones may have learnt something that the new ones have yet to realise ?
 

100andthirty

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I think you will find that the return for the TOCs is 3% of turnover, not capital. The capital invested by a TOC is minimal. However, 3% on turnover is pretty poor too. Yes, if everything goes well, a TOC turning over several hundred million pounds a year will make a substantial sum and a handsome return on the minimal capital employed. But if the TOC's forecasts are a little, say optimistic, then they might turn the profit into a loss.
 

3141

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In principle, the franchise system can work, and did for some TOCs and owning groups in the earlier years of privatisation - provided that they'd got their sums right when they were bidding, which some hadn't.

But there are other factors which may derail a TOC's plans. As the OP observed, currently there are infrastructure delays affecting several TOCs.
GWR has had to acquire a fleet of bi-modes which will be expensive to run and have limitations in diesel mode.
There may be delays to other new rolling stock that's on order, which in turn may delay the point at which a TOC can start increasing its revenue.

The companies that have recently acquired "passports" to bid for UK franchises may be selective in what they bid for. We've yet to see whether they continue to bid, if they don't win anything over the next few years and maybe conclude that to put in a successful bid requires them to offer an amount that they consider too risky. Danish State Railways bid for some franchises about fifteen years ago, but apparently decided it wasn't worth continuing.

It's possible that the level of regulation required by the DfT puts some potential bidders off. I remember Chris Garnett of GNER saying that in the early days of franchising there was little regulation and a lot of energy (= initiatives and innovation), but after a few years it was the other way round.

There'll always be someone who notes that others have run into problems, but feels sure they can do better.
 

Alfie1014

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The reality is that returns across the Transport sector have always been low, (even lower in commercial bus operations). At the dawn of franchising the owning groups (mostly bus based) were more than happy with 3-5% not least because the contracts were 'guaranteed' by Government, cash flow generation can be pretty large, especially on the SE commuter TOCs and the market was expanding. There is no doubt that times are now much harder, bidding is much more expensive, the medium to long term economy is much harder to predict, many infrastructure improvements have been delayed and/or deferred impacting on the cost base and growth seems to be faltering. In the current edition of Modern Railways Roger Ford examines the prospects for franchises, (the article is headed 'The rise of the Zombie Franchises!).

Testing times for the industry over the coming few years and that's without Network Rail's inability to contain its costs!
 

Carlisle

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Monopolistic competition, which TOCs now enjoy, would in theory be an ideal scenario for TOCs to run relatively few trains during peak hours, at a price which fills the train (or just under) but leaves the majority unable to afford. Down tools off peak.
Presumably we’d be travelling on the rail equivalent of those tired old wrecks many bus operators use almost purely on school runs as it wouldn’t likley be worth buying new just to operate in the peaks :D
 

yorkie

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EDIT: the reason it won’t ever be allowed to grind to a halt is the enormous economic externalities that would result. The South East of England and London would cease to function, for one.
If the franchising system grinds to a halt, it would not mean the trains would grind to a halt. There have been plenty of times that a franchise has been extended, and if necessary the public sector can run a train company (For several years Directly Operated Railways ran East Coast).
 

Bromley boy

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Presumably we’d be travelling on the rail equivalent of those tired old wrecks many bus operators use almost purely on school runs as it wouldn’t likley be worth buying new just to operate in the peaks :D
Quite possibly. Mind you given current fare prices and the state of some of the stock currently running around on my patch people might be forgiven for thinking that’s already happened.

If the franchising system grinds to a halt, it would not mean the trains would grind to a halt. There have been plenty of times that a franchise has been extended, and if necessary the public sector can run a train company (For several years Directly Operated Railways ran East Coast).
Exactly. The consequences for the wider economy would be too serious to allow it to happen.
 

Mikey C

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And yet the number of companies with passports to bid for a franchise keeps increasing (most recently RENFE, NTV and Transdev).
Trenitalia is a recent newcomer as a franchisee and is bidding for more.
It's the older set who have run into trouble.
I'm suspicious of the commercial "nous" of some of these newer entrants, I suspect they've piled in (after watching others get involved) thinking it's easy money...
 

Chris M

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Just because an organisation has a passport, doesn't mean they will necessarily bid for a franchise. I would expect that in many competitions we'll see more organisations receiving all the details needed to bid than actually place a bid, with several deciding that it's not worth it.

The fact that the railways can't fail is the reason why they should not be run by the private sector. The private sector only functions when there is all of competition, freedom to innovate and the risk of failure. If any of the three are missing then whatever it is should be run by the state. Currently we sort of have competition, very limited freedom to innovate and principally no risk of failure - a franchisee can just hand back the keys and walk away with only a small penalty.
 

Bertie the bus

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I haven't seen a TOC deliver more than 3-5% return on capital, which is dreadful considering most private companies deliver anywhere between 10-50% depending on the sector.
That is completely untrue. TOCs, generally speaking, make a profit of about 3-5% on revenue. The return on capital investment is huge as they hardly invest any capital.
 

bb21

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The reality is that returns across the Transport sector have always been low, (even lower in commercial bus operations).
Returns are much higher in commercial bus operations, historically around the 10% mark.
 

theironroad

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It seems to me, despite the more left leaning brigade, that the biggest threat to the current TOC model is the complete lack of profits (or in many cases, horrendous losses).

I haven't seen a TOC deliver more than 3-5% return on capital, which is dreadful considering most private companies deliver anywhere between 10-50% depending on the sector. If you combine this with the massive losses that are easy to make (because of delayed infrastructure and other stuff out of the TOCs hands), this is a fools game.

We've already seen a collapse in the number of bidders for future TOCs. I genuinely wouldn't be surprised if there are 0 or just 1 bidder in future, which makes a mockery of the whole process.

Could it be, ironically, that privatised trains are so hard to make money out of that the whole thing grinds to a halt. This, of course, wouldn't be without precedent, as the original rail system from Victorian times until nationalisation was pretty spectacularly unprofitable.
I'm more surprised at your surprise than anything. Shame you had to start your post with a political slur of "left leaning brigade", but anyway.

When considered as a whole network, railways are rarely profitable. Those bits that might make some profit should be used to cross subsidise those that will never make a profit, but have a good reason to be run for the social good.

While true net profit margins are quite low, plenty of cash is extracted from the industry in the franchising process, leasing payments and dividend payments etc and this money could be better used to reinvest in the network rather than leaking out of the industry.

Hopefully the folly of the last twenty years will come to end when zero companies bid for franchises and the network can be returned to a public service.
 

158756

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I'm more surprised at your surprise than anything. Shame you had to start your post with a political slur of "left leaning brigade", but anyway.

When considered as a whole network, railways are rarely profitable. Those bits that might make some profit should be used to cross subsidise those that will never make a profit, but have a good reason to be run for the social good.

While true net profit margins are quite low, plenty of cash is extracted from the industry in the franchising process, leasing payments and dividend payments etc and this money could be better used to reinvest in the network rather than leaking out of the industry.

Hopefully the folly of the last twenty years will come to end when zero companies bid for franchises and the network can be returned to a public service.
Whether the railway network makes a profit is not the issue for the TOCs. Their profit depends on performance relative to the terms of the franchise. It is perfectly possible for a TOC to make large, by the standards of the railway industry, profits running Northern, which obviously loses a lot of money as a whole (ie is massively subsidised by the taxpayer), whilst the TOC on the profitable ECML makes a loss (pays more to the DfT than the profit the line makes).
 

Andrew1395

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The issue of profitability, is surely tested by the number of bids and their quality. For the bus companies it was the weight of rail turnover that made their balance sheets and their shares more attractive to investors. As for overseas transport operators, they are in it for the profit, which is sufficient to make it worthwhile for them.
 

Raul_Duke

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In the earlier days wasn’t it the freight that paid the bills and the passengers were more of an afterthought? Has splitting the two had an effect on overall profitability?
 

Master29

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It seems to me, despite the more left leaning brigade, that the biggest threat to the current TOC model is the complete lack of profits (or in many cases, horrendous losses)..
What`s the "left leaning brigade " got to do with it. The Right leaning brigade aren`t particularly good either are they. VTEC the latest mess.
 

Starmill

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First Group recently said in a statement their their overall rail business is performing well and continues to generate profits for them that they see as at least adequate. A big clue came from an NS International report to the Dutch Government a couple of years ago. They said something about how they were pleased with performance at ScotRail because although their margin had been low at only 2%ish, they had very little capital invested in it. Against that, the 2% of ScotRail revenue was significant. Of course, there are those who clearly thought differently, including National Express who famously have removed themselves from the market entirely.
 

6Gman

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Whether the railway network makes a profit is not the issue for the TOCs. Their profit depends on performance relative to the terms of the franchise. It is perfectly possible for a TOC to make large, by the standards of the railway industry, profits running Northern, which obviously loses a lot of money as a whole (ie is massively subsidised by the taxpayer), whilst the TOC on the profitable ECML makes a loss (pays more to the DfT than the profit the line makes).
This.

I'm amazed how often commentators on the industry (be they enthusiasts, journalists or politicians) don't understand the points made by the above post.
 

ChiefPlanner

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In the earlier days wasn’t it the freight that paid the bills and the passengers were more of an afterthought? Has splitting the two had an effect on overall profitability?
Not in today's UK economy (and not since the Edwardian era I suspect) - all the freight operators make significant losses - bar one -
 

ChiefPlanner

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Freightliner HeavyHaul ??? Profitable in 2015 but not 2016 (most recent accounts available from Companies house).

PS You wouldn't happen to have the limited company / Companies House numbers for the other ones?
Quoting the most recent Modern Railways summary - on the shelves as we speak ..

DB Cargo - income £346M - loss of £58M
DCR - income £2m - loss of £1M
DRS - income £70M - loss of £15M
Freightliner -income £184M - loss of £11M
F/liner Heavy Haul - income £80M - loss of £14M
GB Railfreight - income £127M and profit of £4M

The sources are said to be ORR - 2016 /2017

In the public domain .....
 

theironroad

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I'm no accountant, but as we've seen with Starbucks and Amazon it is possible to make a small net profit for tax purposes and still take cash out of the business via various accounting and tax avoidance strategies, especially when multinationals are involved.

I'm not claiming either way whether tocs and focs are doing this, but if it became tomorrow's headlines I wouldn't bat an eyelid in surprise.
 

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