3.5 There is a risk that the Department's focus on competitive tension in procurements could encourage bids that overestimate passenger demand and revenues, or underestimate costs. This could lead to operators being unable to continue to run the franchise, which happened with the InterCity East Coast franchise in both 2006 and 2009.
3.6 The Department protects itself from the risk of overbidding by assessing the financial robustness of each bid during the evaluation process and securing financial guarantees from the parent companies of operators. In the 2012 InterCity West coast competition, the Department was unclear about how to calculate the level of parent company support it would require from bidders and was inconsistent in the way it applied the model used to calculate this. While it remains to be seen whether the current approach will be effective, the Department has improved the clarity of the process.
Box 1 sets out the Department's current process.
3.7 There can be no guarantee that an operator will not fail, but the Department's approach protects it from excessive risk of supplier failure and ensures that operators have some capital at stake. As we noted in our July 2015 position paper on managing provider failure, the failure of a provider is not necessarily something that should be avoided at all costs. It can be the necessary price of innovation or come from effective competition, keenly priced contracts and robust contract management. However, supplier failure must be managed effectively.9 The Department recognises this tension and the risk that it will have to step in if the operator can no longer run a franchise.
In 2009, we reported on the Department's handling of the termination of the InterCity
East Coast franchise and found that the Department had taken appropriate action and managed costs effectively.
| Box 1 The Department's process for testing the financial robustness of bids The Department carries out risk adjustments to elements of a bid which it feels present a significant risk of a materially different financial outcome to that proposed by the bidder. The Department requires bidders to provide underwritten guarantees of financial support from their parent companies. This aims to protect the taxpayer from the risk of lower premia or higher subsidies than had been contracted. This support is also intended to discourage bidders from submitting overambitious bids. Bidders are required to commit a minimum level of financial support, but can increase this if they feel it would improve the financial robustness of their bids. Bidders are not allowed to offer additional finance during the competition. The Department tests whether the risk-adjusted bids and levels of parent company support result in the bid remaining within a defined set of financial ratios for the duration of the franchise. The Department then assesses the overall risk of default of each bid. Bids that are judged 'high' risk are disqualified. Source: National Audit Office summary of the Department's published tender documents |
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9 National Audit Office (2015), Principles Paper: Managing provider failure, 14 July 2015.