Melbourne’s Train Contracts – Lead up to Refranchising – Risk and Reward
Dollars and sense
The franchise arrangements recognise the commercial reality of public transport operation which requires the provision of a subsidy from the State (the franchise sum) to ensure fares are affordable.
The franchisee earns revenue from its share of farebox, non-fare revenue (like advertising and retail at stations), escrow payments for performing infrastructure maintenance and a margin for assisting the State with delivering rail projects.
The franchise sum is effectively the subsidy the State pays the franchisee to provide the services under the franchise – that is, deliver the timetable!
It’s an annual fixed amount based on the bid timetable and is the calculation of the franchisee operating costs (what it costs to deliver the timetable) plus the franchisee margin, less farebox revenue and non-fare revenue.
Responding to external impacts
Stuff happens. Known risks. Unknown risks. You get the picture. During the term of the franchise, the franchisee can use various mechanisms to protect itself commercially from changes over which it has limited control. It wouldn’t be commercially reasonable to expect a franchisee to bear all the downside from external impacts (provided they weren’t at fault).
Adjustments might be activated where, for example, a force majeure events causes an increase or decrease in operating costs; if a contract variation, specified event or major project causes financial impact to the franchise business, or if there’s a change to rolling stock deployment because of new fleet or a big timetable change. Any of these will trigger a financial discussion and application of procedures under the contract to ensure the franchisee bears no more risk than is commercially feasible.
Farebox takings comprise the most significant income for the franchisee. As you can imagine, COVID has taken a big chunk of change here with falls in patronage during lockdown.
At the start of privatisation, farebox revenue was allocated on a variable basis. This meant that tram and train operators would derive farebox income based on a distribution taking into account ticket sales. The ticketing system to support this distribution was unreliable, among other inconsistencies, and this led to ongoing disagreements as to farebox entitlements across operators – an unworkable position.
Unsurprisingly, the regime was changed a few years following privatisation to a fixed allocation of farebox revenue across operators. I suspect this will not change in the future. Farebox risk is shared with the operator so that it’s incentivised to grow the farebox pie through improved operational performance. Given some of the impacts to farebox are beyond the operator’s control, however, there is a risk protection regime to protect the operator and the State from farebox volatility.
Without doubt, the allocation of farebox risk will be a big discussion in government for refranchising. Allocating any portion of farebox risk to the franchisee will be problematic given the impacts caused by falling patronage on public transport in the wake of COVID shocks.
Escrow regime for infrastructure
Escrow is the mechanism to monitor the release of infrastructure maintenance and renewal (M&R) payments to the franchisee in accordance with its asset management plans. The financial quantum of the escrow is determined by reference to M&R activities included in these asset management plans.
These plans, in simple terms, outline what the franchisee must do to ensure rail assets are maintained in a condition to achieve the State’s asset performance objectives.
Early in the privatised contracts, an escrow was established where the franchisee was able to draw down payments each month for M&R. In practice, however, it was difficult for the State to confirm whether the money had actually been spent on M&R and, if so, on what assets.
The regime changed during the second evolution of the contract and the escrow draw down process was tightened. Now, claims on the escrow are made by the franchisee for works set out in works plans (what was planned and promised), along with supporting material to substantiate the claim (what was actually done in accordance with the plan). Makes sense.
Next time, we take a look at the heart and soul - passenger experience and train operations.