bidding for rail franchises: revenue
Rail franchises are operating contracts, and they come up for renewal after a fixed term (which varies but is very often between seven and ten years).
The operating companies and the Department for Transport both want to get the best possible deal.
The operating companies and the Department for Transport both want to get the best possible deal, but their motives are different.
Bidders must predict revenue in their business plans, but it is in their interests to set the target high. The reverse applies to the DfT. Why?
The ebb and flow of earnings has customarily been protected to some extent, because the DfT has traditionally been obliged to provide ‘revenue support’ if income is significantly lower than expected. On the other hand, if earnings are higher than forecast the DfT starts to be entitled to a slice of this extra profit. The mechanisms have varied in the past, but new franchises now have their premiums or subsidies adjusted in accordance with variations in Gross Domestic Product and also (in south east England) the growth of employment in central London. If revenues are higher than expected (’outperformance’) then, as before, the DfT gets a slice as a profit-share.
It now becomes easy to see why bidders have traditionally predicted high revenue (if their forecasts turned out to be too optimistic revenue support was more likely to kick in, while it also made the chances of reaching the dizzy heights of the profit-share bands less likely).
The DfT's priorities are exactly the opposite. Obviously, there are limits: both sides have access to the revenue figures to date, and anything too radical is unlikely to survive when the various bids for a franchise are compared.