What is a management contract and how is it different from normal rail franchises & the OLR

[Harvey B]

I've been debating on whether to set up this thread for a few days now ever since I first heard of the term of a management contract.

In light of todays announcement that the government has now announced that rail franchises are to be suspended for at least the next 6 months and replacing with management contracts I feel its the best time to start this thread.

As I said further up I first heard of the term "management contract" a few days ago on this forum on the thread linked https://www.railforums.co.uk/threads/british-rail-returning.202229/

A response from @rdlover777 that said:

i posted this in a thread about COVID-19's effect on the railways and its just a management contract

As well as this resonse from @221129 which said

A management contract is not nationalisation. It also doesn't state what the other option being considered is.

These were the first two times that I heard of the term "management contract" and I have seen the term on twitter a few times afterwards.

Since I first heard the phrase I've been wondering what a "management contract" is how it compares to a franchised TOC (such as Avanti, EMR and Transpennine Express) and nationalised operators/OLR (such as LNER and Northern Trains)

 

[ian959]

A management contract simply means the operator will run the trains on behalf of the government for a fixed fee. All revenue received goes to the government, and all expenses are borne by the government. A franchise is where the operator runs the trains but receive all the revenue and bear all the expenses. OLR is where the government company simply replaces the franchisee.

 

[Harvey B]

A management contract simply means the operator will run the trains on behalf of the government for a fixed fee. All revenue received goes to the government, and all expenses are borne by the government. A franchise is where the operator runs the trains but receive all the revenue and bear all the expenses. OLR is where the government company simply replaces the franchisee.

So Im guessing a management contract as basically where the government in some ways becomes a temporary "co-owner" of the franchise

 

[Bletchleyite]

So Im guessing a management contract as basically where the government in some ways becomes a temporary "co-owner" of the franchise

Not as such, it's just a different type of contract. The Government pays the costs of operation plus a profit margin, the operator gives the Government all the revenue.

This type of contract is not unusual on some local authority contracted bus services.

 

[E16 Cyclist]

A management contract simply means the operator will run the trains on behalf of the government for a fixed fee. All revenue received goes to the government, and all expenses are borne by the government. A franchise is where the operator runs the trains but receive all the revenue and bear all the expenses. OLR is where the government company simply replaces the franchisee.

The part I’ve never got is, if the operator receives the revenue and bears all the expenses why does it have to pay the government a premium?

 

[swt_passenger]

So Im guessing a management contract as basically where the government in some ways becomes a temporary "co-owner" of the franchise

The TSGN franchise (publically GTR) has been run on a “management contract” since 2014 so that’s your best current example. It still has the normal look of a franchise, it’s the financial details that matter. There’s still a typical “franchise agreement” for it.

 

[Jurg]

The part I’ve never got is, if the operator receives the revenue and bears all the expenses why does it have to pay the government a premium?

Because the government isn't just a charity for the benefit of big business?

 

[Peter Mugridge]

The part I’ve never got is, if the operator receives the revenue and bears all the expenses why does it have to pay the government a premium?

It's a way, in theory, of removing financial risk from the public purse. As we know, it doesn't always work that way! However, by having management contracts in place a TOC is guaranteed an income - the fixed fee - which in turn guarantees a degree of stabilty with no distractions caused by the TOCs running out of money - and right now this sort of stability is essential.

 

[ainsworth74]

The part I’ve never got is, if the operator receives the revenue and bears all the expenses why does it have to pay the government a premium?

Because it's a franchise. It is admittedly an a-typical expample of such but that is what it is. The premium is effectively the fee paid for the right to run services under contract to the Government.

McDonald's is perhaps an easier example to understand than the variant used on the railway. The majority of McDonald's are franchises, they are not operated directly by the McDonanld's corporation and are instead operated by individuals or groups who think that their highstreet/shopping centre/retail park/etc would be fertile ground for such an operation. They therefore apply to McDonald's for the rights to open and run a branch with the branding, supply chain, training materials, etc and in exchange they pay a fee to McDonald's for all of that. If the franchise fails McDonald's don't lose out and if you stop paying the fee they can close you down for breach of contract.

Railway franchising in principle works a very similar way but obviously there are significant detail differences (one very obvious example is that branding often changes when the franchise changes hands). So why do they pay a premium? Because they don't own it, they're franchised to run it and that's the fee they pay for the right to do so.

 

[dk1]

Virgin Trains operated on a similar management contract for several years after the failure of Railtrack & its planned WCML upgrade in 2002.

 

[LNW-GW Joint]

The TSGN franchise (publically GTR) has been run on a “management contract” since 2014 so that’s your best current example. It still has the normal look of a franchise, it’s the financial details that matter. There’s still a typical “franchise agreement” for it.

The emergency management contracts have a different feel, though, as HMG is covering all costs (against services they specify).
I think previous management contracts (eg Virgin Trains for a number of years) have targeted revenue and costs to deliver a profit/loss share between TOC and DfT.
ie there was an incentive on the TOC to increase revenue/decrease costs.
No doubt we'll find out who is the "rail supremo" in all this.
Somebody must have set the parameters for the sharply-reduced services we see from today.
I wonder where the delivery/introduction of new trains comes in the priority at the moment - not high I suspect.
On the other hand DfT won't want the UK manufacturing side to grind to a halt.
Contracts also have to be honoured.

 

[Taunton]

The part I’ve never got is, if the operator receives the revenue and bears all the expenses why does it have to pay the government a premium?

The operator is the one that gets the ticket money and pays all the suppliers and employees. They also get a fixed fee for managing all this, including then putting all the accounts together. Whatever the difference, the government pays the operator, or if there is a surplus (unlikely at present) the government gets it.

This sort of arrangement is common across the commercial world for all sorts of things, like some construction works. Commonly known as "cost plus".

 

[hwl]

The emergency management contracts have a different feel, though, as HMG is covering all costs (against services they specify).
I think previous management contracts (eg Virgin Trains for a number of years) have targeted revenue and costs to deliver a profit/loss share between TOC and DfT.
ie there was an incentive on the TOC to increase revenue/decrease costs.
No doubt we'll find out who is the "rail supremo" in all this.
Somebody must have set the parameters for the sharply-reduced services we see from today.
I wonder where the delivery/introduction of new trains comes in the priority at the moment - not high I suspect.
On the other hand DfT won't want the UK manufacturing side to grind to a halt.
Contracts also have to be honoured.

Pretty similar to GTR though

 

[jon0844]

The Internet is full of people who seem to think TOCs should have taken the hit, but nobody could have ever factored such a scenario in their bids. They'd bid on the basis of attempting to grow the railway, and taking a risk on that not happening - but not to this degree. An 80% drop in passenger numbers (and likely to fall further if there's a lock down of all but key workers)? Yeah, I doubt the DfT asked for them to plan for this.

Imagine if they had been asked to plan for such an incident, and how it would have increased the cost of the bids!

This is the best possible solution given unprecedented circumstances.

 

[DarloRich]

The Internet is full of people who seem to think TOCs should have taken the hit, but nobody could have ever factored such a scenario in their bids. They'd bid on the basis of attempting to grow the railway, and taking a risk on that not happening - but not to this degree. An 80% drop in passenger numbers (and likely to fall further if there's a lock down of all but key workers)? Yeah, I doubt the DfT asked for them to plan for this.

Imagine if they had been asked to plan for such an incident, and how it would have increased the cost of the bids!

This is the best possible solution given unprecedented circumstances.

Agreed - little option.

 

[Ianno87]

The Internet is full of people who seem to think TOCs should have taken the hit, but nobody could have ever factored such a scenario in their bids. They'd bid on the basis of attempting to grow the railway, and taking a risk on that not happening - but not to this degree. An 80% drop in passenger numbers (and likely to fall further if there's a lock down of all but key workers)? Yeah, I doubt the DfT asked for them to plan for this.

Imagine if they had been asked to plan for such an incident, and how it would have increased the cost of the bids!

This is the best possible solution given unprecedented circumstances.

...and indeed if the TOCs did just 'take the hit', they all go bust and we'd end up with OLR anyway, so little difference in outcome; the approach announced this morning at least gives some stability and control.

 

[43096]

Railway franchising in principle works a very similar way but obviously there are significant detail differences (one very obvious example is that branding often changes when the franchise changes hands). So why do they pay a premium? Because they don't own it, they're franchised to run it and that's the fee they pay for the right to do so.

Of course many franchises don’t pay a premium, so the bidders are bidding - in simple terms - for the lowest subsidy.

 

[ainsworth74]

Of course many franchises don’t pay a premium, so the bidders are bidding - in simple terms - for the lowest subsidy.

Yes, another fun quirk of the system and why, in reality, franchise is probably a poor choice of description.

 

[edwin_m]

Another way of looking at this is about risk. With a "classic" franchise the TOC takes the risk that the revenue falls short of forecasts or costs are higher. The principle was to incentivize the TOC to do whatever it could to maximise revenue and minimize costs, which in theory results in a better and more efficient service. For all sorts of reasons this hasn't really worked, as in reality most of the revenue and a lot of the costs are outside the TOC's control, and TOCs may look for ways (like poaching from other TOCs) to maximise their profit that don't actually maximise overall ridership or make life better for passengers.

As mentioned this becomes unworkable if an external event invalidates all the assumptions made at bid time ("force majeure" is the legal term). This essentially happened with Northern with the assumed infrastructure schemes not happening, and Covid-19 is now doing the same in a more severe form to every franchise. Under the management contract the franchises are essentially run by DfT on a command and control basis, although retaining their existing management who hopefully know the ropes better than some external party would.

 

[717001]

Under the management contract the franchises are essentially run by DfT on a command and control basis, although retaining their existing management who hopefully know the ropes better than some external party would.

Hopefully the DfT will allow some scope for local decision making and not want to ratify every small thing prior to implementation. Otherwise there's going to be a very full in-tray somewhere in the DfT.

 

[Skoodle]

This is pretty much how Arriva Rail London runs on a "concession" agreement with TfL.

 

[Kite159]

This is pretty much how Arriva Rail London runs on a "concession" agreement with TfL.

And I would imagine similar to MTR running the TfL Rail concession (and maybe Serco/Abellio with Merseyrail)

 

[GRALISTAIR]

Hopefully the DfT will allow some scope for local decision making and not want to ratify every small thing prior to implementation. Otherwise there's going to be a very full in-tray somewhere in the DfT.

I totally agree. Where is the full unedited Williams review when we need it?

 

[AM9]

Another way of looking at this is about risk. With a "classic" franchise the TOC takes the risk that the revenue falls short of forecasts or costs are higher. The principle was to incentivize the TOC to do whatever it could to maximise revenue and minimize costs, which in theory results in a better and more efficient service. For all sorts of reasons this hasn't really worked, as in reality most of the revenue and a lot of the costs are outside the TOC's control, and TOCs may look for ways (like poaching from other TOCs) to maximise their profit that don't actually maximise overall ridership or make life better for passengers.

As mentioned this becomes unworkable if an external event invalidates all the assumptions made at bid time ("force majeure" is the legal term). This essentially happened with Northern with the assumed infrastructure schemes not happening, and Covid-19 is now doing the same in a more severe form to every franchise. Under the management contract the franchises are essentially run by DfT on a command and control basis, although retaining their existing management who hopefully know the ropes better than some external party would.

Although 'force majeure'' is a possible cause of a TOC to fail in performing to contract, in this instance, the Government actions of restrictions on movement, closure of businesses, (so far mainly those that tend to gather customers together thereby risking disease spreading, but much more is to come); given the nature of the TOCs deliverables, the above Government acts could easily be described as causing 'frustration of contract' i.e. making it impossible for TOCs to fulfil their contract obligations. Hence the move to management contracts. The GTR contract under a franchise would probably have been handed back had there been significant problems with the Thameslink programme, and of course, the DfT were quite happy to pay for GTR to fight a proxy war with the unions over DOO rather than have GTR walk away when the DfT fought that battle directly.

 

[Andyh82]

The Internet is full of people who seem to think TOCs should have taken the hit, but nobody could have ever factored such a scenario in their bids. They'd bid on the basis of attempting to grow the railway, and taking a risk on that not happening - but not to this degree. An 80% drop in passenger numbers (and likely to fall further if there's a lock down of all but key workers)? Yeah, I doubt the DfT asked for them to plan for this.

The internet is full of people who think the TOCs make millions of pounds of profits though, so they aren’t well informed.

 

[geoffk]

Local authority bus service contracts, which which I was involved between 1986 and 2007 when I retired, are typically let as "minimum subsidy" or "minimum cost", sometimes called fixed price or revenue guarantee. In the minimum subsidy contract, the operator bids for a fixed sum from the local authority and keeps the fare revenue, so has an incentive to market the service but takes the financial risk if revenue falls below what was estimated. The minimum cost contract places the risk with the local authority which pays a fee less the fare revenue taken. In the latter case the local authority's budget is more uncertain but, with a large number of these contracts, I found that there was a "swings and roundabouts" effect. Minimum cost contracts tend to get more operators bidding and are particularly useful for a new bus service for which there is no information about revenue.

 

[SteveM70]

As mentioned this becomes unworkable if an external event invalidates all the assumptions made at bid time ("force majeure" is the legal term). This essentially happened with Northern with the assumed infrastructure schemes not happening

That isn’t force majeure as it was in the direct control of one of the parties to the contract. Northern’s legal argument would likely be frustration of contract, as the other party has made it impossible for them to fulfil their side of the deal

 

[edwin_m]

That isn’t force majeure as it was in the direct control of one of the parties to the contract. Northern’s legal argument would likely be frustration of contract, as the other party has made it impossible for them to fulfil their side of the deal

I was referring to the virus as force majeure. I'm not sure what NR's failure to deliver infrastructure for Northern would count as, as they aren't a party to the franchise agreement.

 

[hwl]

I was referring to the virus as force majeure. I'm not sure what NR's failure to deliver infrastructure for Northern would count as, as they aren't a party to the franchise agreement.

But DfT not funding NR to carry out certain works required to enable the a given timetable is indirectly

 

[LNW-GW Joint]

But DfT not funding NR to carry out certain works required to enable the a given timetable is indirectly

DfT did fund NR for the work in CP5 (bar P15/16 at Piccadilly), but they spent the money elsewhere, mostly on electrification overspend.

This piece in Railway Gazette paints a rather different picture about the emergency TOC contracts.
It's a choice for the TOC to accept the new terms, carry on under the current terms, or hand over to OLR.
It's clear that First Group, at least, has accepted the emergency terms for GWR and TPE (and presumably SWR with MTR).
Some statement on the future of South Eastern and Great Western franchises is due by the end of March.

The union comments, after saying they do not want to make political points at a time of crisis, go on to make the usual political points including demanding "cast iron guarantees" on the employment of all staff and contractors.

https://www.railwaygazette.com/uk/u...nt-contracts-or-nationalisation/56083.article
​

TOCs are free to accept these arrangements, or to choose to continue under the existing contractual arrangements. The government’s Operator of Last Resort also ‘stands ready to step in’, DfT said.
The EMAs will freeze all existing responsibilities and liabilities until September 20. DfT plans to review the situation in six months, or sooner if required, and said mutually-agreed extension or early cancellation of an EMA is possible if required.
DfT told Rail Business UK that an announcement regarding the Southeastern and Great Western franchises, which are due for renewal, would be made by the end of March