McNulty Review

Will it put the rail sector back on track?

June 2011

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Executive summary
The McNulty report published on the 19th May 2011 has made a number of recommendations to overhaul the UKs rail network. Key to the report is the need for efficiency savings to be made whilst not compromising the capacity of the system and allowing for future growth. The scopes of the efficiencies in the report are substantial in size, with McNulty indicating that the industry should be aiming to achieve a 30% reduction in unit costs (i.e. costs per passenger-km) by 2018/19. This will certainly be a challenge. For example, if you were to ask most households to reduce their spending by 30% many would struggle. As one can imagine there is no single item that will make up these efficiencies and similarly the acknowledgement that there is no silver bullet in the rail sector is welcome. However, given there is no silver bullet a wider variety of policy changes will be required and whilst this may result in a more efficient rail sector in the medium to long run it is vital to ensure that short run operations and investment are not too severely impacted. Industry has offered innovative schemes in the past, but clearly there is room to do more. This requires a further improvement in the client supplier relationship, and given the scale of the challenge engagement will need to improve significantly. Transparency and policy certainty will be key for any industry, as is clarity on the direction government wishes industry to go that instils confidence. It is important to remember that policy uncertainty does carry a premium. The reports recognition that fragmentation, excessive government intervention and lack of collaboration has created a system whereby the likely direction is the one in which it is heading is a start to recognising some of the inefficiencies that occur. The misalignment of incentives has created inefficiencies, and it is important to address this. The key to efficiencies will not be necessarily by addressing the differential between opex and capex but more importantly the way in which they are integrated and performed. The direction and implementation of policy should be consistent and encourage industry involvement. Throughout the whole process incentives, policy and

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regulations should all be tailored towards the efficient delivery of a cost effective rail network. It is also important that given the extent of the changes proposed that funding certainty is considered with regards to the subsidy of the railways, and the increase in prices. Volatility in these areas creates uncertainty for investors and those companies operating in the market. ACE welcomes the reports proposal of whole life thinking, and as a function of this cost will be an important factor. If the government wishes to meet its carbon targets sustainability will need to become of ever increasing importance. However, it should be stressed that an efficient cost effective railway does not mean that every project is always delivered under the scheme which has the smallest cost. The reports recommendation with regards to the decentralisation of Network Rail could provide significant benefits responding more proactively to specific issues within regional areas. The challenge will be maintaining a national direction in terms of system integration and harmonisation and knowledge transfer between these decentralised entities. For the efficiency gains proposed to succeed the benefits should flow easily across the entire network. A final key area in the report is that of overheads and administration, ACE has campaigned for significant improvements to be made in procurement and planning processes. ACE recommends government consults wider with stakeholder on these issues in detail given their potential for efficiencies.

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Review of recommendations
The release of the McNulty report is welcomed by ACE as providing a long overdue critique of the rail sector in the UK. In the publics eyes this is long overdue, and the importance of infrastructure and the improvement of the UKs in terms of its performance when considered against its international competitors is key. Key to the report is the need for efficiency savings to be made whilst not compromising the capacity of the system and allowing for future growth. The report found that further benchmarking has identified an efficiency gap of 40% against four European comparators. Some of that 40% gap may be systemic, and therefore cannot be eliminated fully, but I believe that the industry should be aiming to achieve a 30% reduction in unit costs (i.e. costs per passenger-km) by 2018/19. The reports acknowledgement that there is no silver bullet is welcome along with the recognition that to achieve a 30% efficiency saving a substantial programme of change is required. Given the scale of the task and the challenges that both companies and employees will face in shifting away from the old way of doing things it is important that all stakeholders align and understand the new policy approach. Within this, it is important to recognise that the effect on consumers must be minimal. The report makes clear that GB rail fares are already too high. Given this, consumers will not be willing to suffer reductions in service quality as the reform process takes place. Whilst there may be some short term disruption to achieve a more efficient rail network in the long run, it is key that suppliers, clients and government explore innovative methods of working that minimise disruption. Thoughts on the key issues raised in the McNulty review: Much of the responsibility for costs is seen to rest with Government, and industry has not taken the responsibility which it needs to exercise for driving costs down. Industry has offered innovative schemes, but clearly there is room to do more. This requires a further improvement in the client supplier relationship. This will mean that client and stakeholder engagement must improve significantly.

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Throughout the whole process incentives, policy and regulations should all be tailored towards the efficient delivery of a cost effective rail network. Government is seen as being involved in detail in the industrys affairs, and yet is not providing sufficient clarity about what Government policy is, how different strands of policy fit together, or how the different levels of policy, objectives strategies and implementation are linked. Policy certainty is key for any industry, as is clarity on the direction government wishes industry to go. It is important to remember that policy uncertainty does carry a premium. The fragmentation and number of players in the rail sector has meant that they have not worked well in terms of securing co-operative effort at operational interfaces or active engagement in cross-industry activities. This is not unique to the rail sector, but does create uncertainty and risk. Once again this will filter through into the cost of the rail network. Improved collaboration between stakeholders is welcomed by suppliers however, such collaboration needs to be encouraged through the procurement processes and contract structures. If blocks on collaborative working exist in these areas it will make the task of delivering projects collaboratively difficult even with suppliers backing. One of the principal barriers, if not the principal barrier, is the lack of an effective supply chain that starts with the customer (passenger and freight) and taxpayer, and focuses the efforts of all concerned on meeting these needs in a cost-effective manner. ACE agrees that it is important to focus on the needs of ultimate customers. Network Rail has often worked in a centralised manner and is insufficiently concerned with the needs of its customers The recent plans to restructure Network Rail have significant potential in terms of improving the quality of the railways, the relationship with the supply chain, and encouraging efficiency. However, the key to its success will be the active involvement of stakeholders and suppliers. We welcome the opportunity to be involved in this process. There is a misalignment of incentives within the industry with both Network Rail and the TOCs incentives being completely different.

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Incentives overall appear to have a bias towards capital expenditure rather than making better use of existing capacity. The misalignment of incentives has created inefficiencies, and it is important to address this. The key to efficiencies will not be necessarily by addressing the differential between opex and capex but more importantly the way in which they are integrated and performed. It is not efficient to send out multiple teams to perform different improvements when closer collaboration and better working practices could mean the team already on site could perform the required duties. The fare structures within the industry do not send efficient pricing signals. Efficient pricing mechanisms are important in guiding investment within industry, which in turn would lead to a more efficient cost effective railway. It is important that any new regulatory system aimed to guide investment efficiently. GB rail lacks best-practice in a number of areas which need to be managed from a whole-system perspective and which are key drivers of costs ACE welcome whole life thinking, and as a function of this cost will be an important factor. In addition, if the government wishes to meet its carbon targets sustainability will need to become of ever increasing importance. However, it should be stressed that an efficient cost effective railway does not mean that every project is always delivered under the scheme which has the smallest cost. The industrys legal and contractual framework is complex and arguably has adverse effects on attributes and relationships, as well as engendering additional costs. Complexity increases legal costs and raises the likelihood of disputes and inefficiency. For example, ACE continually highlights the wastage that occurs across all sectors due to bespoke procurement requirements. Harmonising and simplifying these processes would significantly reduce the amount of time industry spends administering such items, reducing overheads and the cost to government as a client. Given these issues, the McNulty report has outlined a number of recommendations. These are generally accepted by ACE but continued

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engagement with all parties throughout implementation will be key. For this reason ACE has added comments to some of the recommendations below: The Department for Transport (DfT) to develop a clearer definition of the roles of Government and industry, with Government focused primarily on setting the overall vision for the industry, the direction of rail policy, the objectives for the industry, the level of funding available, and leading on franchising procurement. Government to provide greater clarity about what Government policy is, how different strands of policy are harmonised, and make clearer the links between the different levels of policy, objectives, strategies and implementation. ACE welcomes these recommendations; it is important that each government department is aware of its remit and responsibilities. The direction and implementation of policy should be consistent and encourage industry involvement. Funding certainty will be important, the changes announced to the subsidy of the railways, and the increase in prices will create uncertainty for investors and those companies operating in the market. As recognised in the report efficient pricing mechanisms are required to encourage investment and consumer usage. The industry to accept greater responsibility for strategic planning and the delivery of outcomes in line with Governments policies and objectives, particularly on cost reduction. ACE welcomes efforts to work closer with industry, the expertise and knowledge base of industry will be key in delivering efficiency savings. Whilst there should always be attention paid to the cost aspect of projects; it is important to consider this in relation to the whole life benefits of the project and the objectives that are set. This relates back to the first recommendation in so far as consumer demand drives government policy which in turn needs to provide a clear indication as to how it wants the UKs future rail network to look, whether low carbon, low cost, high speed, or a clearly defined balance of the three. The industry to establish a Rail Delivery Group, consisting of the most senior people from NR and the TOC-owning groups, freight and other stakeholders, to lead a substantial programme of change focused particularly on cost reduction, changing the industry culture, encouraging

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more integrated whole-system approaches where necessary, and improving the speed and effectiveness of cross-industry bodies. Mechanisms for establishing a dialogue at industry level with the trade unions should also be explored. Engagement at this level is essential and ACE would urge that the process involves the right stakeholder at the right level. The High Level Output Specification (HLOS)/Statement of Funds Available (SoFA) process to include specific cost objectives and a greater degree of longer term planning. The provision of certainty is a must moving forward. For investors and companies to assess risk and returns it is essential that they know exactly what funding streams and financing options are and are not available. There should be a move away from predict and provide to predict, manage and provide, with a much greater focus on making better use of existing system capacity. The emphasis on managing the network is welcomed. It is important that the network is managed to minimise pinch points and inefficient practices. In addition to this technological advances should be utilised where possible to run more trains, on time, on the same network. The DfT to work with industry to develop a comprehensive analysis of how subsidy is used, i.e. where subsidy is used and what it is buying; the DfT should then assess how this use of subsidy contributes to Governments policy objectives. Analysis of spending is important, and should be standard practice at all levels of government. Transparency is key so that industry can provide solutions and engage in open debate as to which solutions work best and minimise costs. Less prescriptive franchises to allow TOCs more freedom to respond to the market. This is key to delivering efficient pricing mechanisms. To attain the greatest level of efficiency it is essential that the TOCs are able to engage with the wider industry and supply chain to react to market conditions in an unconstrained manner.

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Devolution and decentralisation within NR. o o o o o Introduce diverse ownership of some infrastructure management concessions. Closer alignment of route-level infrastructure management with TOCs, at one or other of the following levels: minimum cost and revenue sharing, and joint targets; or intermediate joint ventures or alliances; or maximum full vertical integration though a concession of infrastructure management and train operations combined.

The decentralisation of Network Rail could provide significant benefits responding more proactively to specific issues within regional areas. However, it is important that there is a national direction in terms of system integration and harmonisation. In addition to this a network should be put in place to transfer knowledge between these decentralised entities. Efficiency benefits should be allowed to spread across the entire network. ACE agrees that there will be no one size fits all approach and so see a variety of the options above as the most likely occurrence. However, this does provide some uncertainty at this point in time as to the exact structure of Network Rail, its responsibilities and its interaction with the industry. We would urge government to outline transparently the changes it proposes. A greater degree of local decision-making by PTEs, and/or local authorities, brought more closely together with budget responsibility and accountability. Local input is important in projects and utilising local funding effectively can deliver more efficient schemes. However, it is important that a balance is ascertained so that resources are balanced correctly, enabling larger scheme to be delivered. Local solutions do not always consider the wider implications or possible efficiencies that could occur given a broader picture. The Study recommends having at least two joint ventures/alliances in place by 2013/14 and at least one vertically-integrated pilot in place by about the same time. The time scale proposed above is reasonable given the degree of consultation and industry input that should take place to effectively set up and deliver works through these proposed structures.

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Reform of franchising, along the lines already announced by Government with much stronger incentives for TOCs to reduce costs, and to co-operate more effectively with NR.

The cooperation between TOCs and Network Rail is important. However, industry involvement will also be important if efficiency is to be found in this area. It is important for industry to understand where responsibilities lie. For example, would it be possible for a TOC to form a joint venture with an industry partner to deliver all the infrastructure functions of part of the rail network, reducing Network Rails role to a minimum? Closer alignment of NR and TOC incentives through the structural changes indicated above. Providing the right incentives here will be imperative. For this reason it would be important to have industry-wide and passenger views on the structure of these incentives to ensure that they are truly aligned with delivery a low cost, safe, reliable and efficient network. In relation to NR: o o o o o comparative regulation of route-level units; introducing a degree of independent ownership of infrastructure management concessions; consider directing all subsidy for NR through track access charges; develop improved corporate governance and a better focused management incentive programme; and assess the potential, after industry structures stabilise, for unsupported debt and/or private investment.

There are concerns in the industry as to how exactly these measures will be implemented. It is essential that government outlines a roadmap of how and when it expects these changes to occur. Improved incentives for efficient enhancements.

Assuming the regulatory environment is designed effectively one should not have to incentivise efficient enhancements. Currently sub optimal behaviour is incentivised. Improving incentives and clarifying responsibilities for the efficient management of existing capacity.

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Greater transparency of the industrys finances and cost performance.

Transparency is important. It allows consumers, investors and rail operators to target inefficiencies and direct investment. ACE would recommend that the rail sector look at the examples of the energy market in Europe, which has created an EU platform that reports gas/electricity flows across borders as an example of how information can be presented to a wide variety of market participants. It is important that the information collected is comparable and accurate to allow meaningful conclusions to be drawn. Move towards the industry having a single regulator, the ORR, with a new focus on whole-system outputs and with the necessary resources, skills and standing to support an expanded role. The current lack of direction, poor performance and inconsistency in the sector provide a strong case for a single powerful regulator. This regulator should be empowered to ensure that it can take the actions necessary to ensure efficient market conditions take place. The DfT to undertake a full review of fares policy and structures, aiming to move towards a system that is seen to be less complex and more equitable, and which also aids the management of peak demand and the more efficient matching of demand with capacity. The Studys recommendations envisage some re-balancing of fares but no increase overall. The DfT to work with industry to accelerate Smartcards, other retail technologies and introducing other retail locations. The DfT, in liaison with the industry, to overhaul the Ticketing and Settlement Agreement which prescribes such matters as ticket office opening hours, providing other enabling pre-conditions are met. These initiatives are welcomed by ACE. It is important that pricing signals are effective for investment. Within this, systems across the network should be compatible, which would help to improve the efficiency of station and rail movements. Industry wide adoption of modern, best-practice frameworks to encourage whole-system, whole-life approaches, focusing particularly on considering all available options fully before fixing on the solutions

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Making best use of the new objectives, incentives, structures and interfaces to achieve improved trade-offs between infrastructure, rolling stock and operations

ACE believes that an holistic approach to infrastructure should be taken. This should encompass a wide variety of factors such as capex cost, opex cost and sustainability, and would help to ensure that an efficient solution is delivered. Better selection of the optimum maintenance approaches, informed by better understanding of assets and better asset condition information to reduce maintenance and renewals effort; Better visibility of forward plans and less volatile workloads to encourage long term investment by suppliers in whole life solutions and cost reduction approaches; Earlier involvement of suppliers and contractors, and much wider use of partnering approaches, to incentivise all parties to reduce the cost of delivering rail services. Clearer safety leadership at industry level to drive further improvement in the rail safety culture. Establishment of a Rail Systems Agency (RSA) to lead the industry in achieving technical excellence in standards management, technical integration, and driving innovation. Review of many aspects of staffing and working practices. The need for improved training and people development. Improved oversight and management of cross-industry information systems. The above recommendations are important, as with the transparency of information on performance, the dissemination of best practice, innovation and the ability to predict workloads is key to industry. Companies will struggle to gear up and deliver the next generation of rail if they do not know it is coming. The need for pay restraint in relation to both staff and senior management. Whilst there will inevitably be an incentive to enforce pay restraint, caution must be urged. Companies are now operating in global markets and will therefore

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direct resources where they see the most tangible benefit. A loss of skilled staff in this area will inevitably result in reduced productivity and lower levels of innovation. This would subsequently result in a less efficient outcome and drive costs up instead of down. Review of overheads and administration.

ACE has campaigned for significant improvements to be made in procurement and planning processes. ACE recommends government consults wider with stakeholder on these issues in detail given their potential for efficiencies. If such improvements were to be put in place this would reduce the overheads of industry and allow projects to be delivered at lower cost. Increased standardisation and more effective procurement of rolling stock, plus establishing strategic partnerships with the ROSCOs. Standardisation will help to drive some efficiency savings. However, it is important to remember that standardisation if implemented too extensively limits innovative capacity and may increase long term costs. Piloting more differentiated approaches for both infrastructure and operations which can maintain standards of safety, but which can reduce the costs of less intensively used networks. ACE welcomes differentiated approaches a one size fits all approach will not work. However, it is also important that in doing so industry is not overburdened with bespoke arrangements as this will drive up operating costs. A small independent team for change programme management to work closely with the Rail Delivery Group, and to report direct to the Secretary of State against an agreed implementation plan. ACE welcomes efforts such as these to encourage participation and improve communications between stakeholders in the industry.

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