2.9 To protect value for money in the absence of competition, the Department brought in staff with strong commercial skills and extensive experience in the rail industry to work on direct award negotiations. The Department used two main approaches during the negotiations. First, the Department sought to introduce an element of competitive tension in its negotiations by retaining the option to transfer the service to another provider or run a full franchise competition if it could not reach agreement on the terms of a direct award. The Department kept Directly Operated Railways (DOR), the publicly-owned rail operator that ran the InterCity East Coast franchise from 2009 to 2015, mobilised throughout negotiations. Operators told us that they considered this to be a genuine risk to them securing the contract. In June 2015, the Department demonstrated that it was prepared to use one of the alternative options when it decided to halt negotiations with South West Trains and bring forward a franchise competition for the South Western franchise.
2.10 The Department's second approach was to develop benchmarks or comparators that provided an indication of the level of premium or subsidy and level of service that the Department would regard as acceptable. It used these as the basis for negotiations with incumbents. The Department used two models:
• a 'top-down' model based on the Department's central long-term forecasts, which simply projected the performance of the current franchise into the future; and
• a 'bottom-up' model that included assumptions about what the incumbent might offer in response to the Department's specification.
2.11 For the early direct awards the Department used a conservative approach to judge whether it was getting value for money, which was not designed for the purpose. The Department used its top-down model both as a forecast of future premia (payments from the operators of profit-making franchises, to the Department) or subsidies and also as a tool on which to base its departmental budgets. Because the model was used as a budgeting tool, the Department built in contingency to manage the risk that it would break the budget, which resulted in a conservative benchmark. From April 2014, the Department replaced this conservative benchmark with a more ambitious benchmark to use in negotiations. While we cannot directly evaluate the effect of this changed approach because the premia or subsidies from different franchises are not directly comparable, this change should have resulted in improved value for money.
2.12 The contracted premia that the Department has achieved for direct awards are significantly lower than it has achieved from competitions, when compared to the comparator models used for each franchise:
• For the three franchise competitions completed so far, the overall contracted level of premium during the core years of the franchise is 82% higher than the figure shown in the Department's comparator models (see paragraphs 3.3 and 3.4).
• Across the direct awards negotiated so far, the overall contracted level of net premium is 32% higher than the Department's comparator models.
These figures suggest that competition is important for improving returns to the taxpayer. However, there are other factors at play. For example, direct awards are relatively short, meaning that there is less incentive for operators to invest in measures to improve returns. Also, the franchises where competition has taken place have different characteristics from those where the Department has used direct awards.