Poisoned chalice: Why the East Coast franchise keeps failing

Wednesday’s news that the East Coast rail franchise would once again fall into government hands marks the third time since privatisation that the high-speed route between London and Scotland has failed.

It means the franchise has never been successful in private hands - despite being one of the busiest intercity routes with some of the priciest tickets, serving large urban areas including London, York, Lincoln, Newcastle and Edinburgh.

So, why is this route a particular poisoned chalice for any corporate hands that touch it?

1996-2006 The Sea Containers Years

The East Coast route was first let to now-defunct freight giant Sea Containers upon the privatisation of British Rail in 1996, which operated it under the brand name GNER.

GNER had grand plans for the route, starting with the modernisation of the then-still young InterCity 225 trains under what was called the ‘Mallard programme’, as well as upgrading the ageing Intercity 125 fleet and operating leased surplus Eurostar trains.

It was indeed initially successful, having its initial term extended from 2003 until 2005, and then being re-awarded the franchise for another seven years from May 2005.

But in early 2006, it was revealed that Sea Containers was circling the drain, with questions arising as to whether GNER could continue operating should its parent company go under.

Sea Containers rejected concerns that GNER was at risk, claiming that its assets and lines of credit were ring-fenced away from the parent company - but that didn’t stop rival train operators such as Virgin Rail, and the industry press from continuous speculation about its financial stability.

GNER was also hurt by the advent of ‘open-access’ operations on its route by Grand Central - these are rail operations that are not tied to government franchises.

Grand Central won the right to call at York, despite protest and even a judicial review from GNER, which was one of the latter’s most lucrative destinations.

Over the ensuing months, it emerged that GNER’s problems were being exacerbated by its own poor profitability, which were linked to an overbidding for the franchise and crippling premium payments to Westminster.

It pinned the blame for its deteriorating finances on a number of factors, including the 2005 London terror attacks, rising electricity prices, the increasing popularity of internal low-cost flights, and a new faster service on the West Coast route between London and Glasgow.

In October 2006 Sea Containers filed for Chapter 11 bankruptcy in the US, and in December the Department for Transport (DfT) stripped it of the East Coast franchise. Given Sea Containers was still trading under Chapter 11 protection, GNER was allowed to continue running services until a new franchise holder was found.

2007-2009 National Express defaults

In August 2007, the DfT announced that National Express had won the bid to take over the route from the ailing Sea Containers, and started operations in December of that year.

National Express committed to a £1.4bn premium for the seven year franchise - a sum many analysts said was too much, even after the previous GNER franchise failed for similar reasons.

It took little more than a year for the cracks to begin to show, with National Express seeing a 1% decline in ticket revenue in the first half of 2009, against projections for improved turnover.

To cover the revenue shortfall, National Express levied passengers with a £2.50 charge per leg just to reserve a seat.

In April of 2009, it told the market it was in discussions with the Westminster over financial assistance - either a reduction in its premium commitment, or some other help.

But just two months later, the London-listed passenger transport operator said it would default, its negotiations with the government having collapsed.

The National Express Group said it would provide no further financial support to ensure the East Coast route’s solvency, meaning the franchise would run out of cash by the end of 2009.

As a result, the Department for Transport established a state-owned operator - East Coast Trains - to take over the route’s operations.

The state continued to operate East Coast until 2015, rather ironically becoming not only the most successful operator in the route’s privatised history, but the most profitable operator on the British railways during its tenure.

2015-2018 Virgin and Stagecoach tie the knot

After much wrangling over the franchise letting process, and a change of government, a joint venture 90% owned by Stagecoach and 10% owned by the Virgin Group took over the East Coast route in March 2015, as Virgin Trains East Coast.

The franchise was initially intended to run until 2023, but as with the previous two, holes in its finances began to show and in 2017 the joint venture told the government that it could not meet all of its premium obligations.

In late 2017 its tenure was cut back to 2020, saving Stagecoach and Virgin an estimated £2bn in premium payments, but Stagecoach still confirmed to the market that it had already lost £200m.

Early in 2018, transport secretary Chris Grayling conceded that the franchise had become "unsustainable", and instructed civil servants to investigate options for its future.

That led to Wednesday’s announcement, in which Grayling said the so-called ‘operator of last resort’ - i.e. a state-owned - as held the franchise between 2009 and 2015 - would take over the route in mid-2018.

The new operator will this time be known as London North Eastern Railway, or LNER - being named after the railway company that operated from 1923 until it was nationalised into British Railways in 1948.

The future

The DfT won’t want the franchise to be in public hands for long - the third failure of one of the biggest franchises is an embarrassment for a government that has trumpeted the virtues of a privatised railway.

Transport Secretary Chris Grayling, a staunch opponent of public ownership, has already refused the Greater London Authority its wish to take London’s suburban railways into public hands as part of Transport for London.

He’s also overseen the massive fiasco that Govia Thameslink Railway - part-owned by FTSE 250 firm Go-Ahead Group - became after it announced plans to change the role of guards on its Southern services from one of safety, to a customer service-oriented job.

That led to a raft of strikes which displaced thousands of London commuters and even caused job losses and a slump in property sales activity along Southern’s routes - but Grayling stuck to his guns, and the situation appears to be largely resolved.

Still, the problems of the East Coast route seem obvious - every franchise holder has ended up overburdened, and struggling to pay its premiums to Westminster.

Some franchises in the UK are subsidised - these are mainly smaller routes and areas where trains serve more of a social purpose than a commuting one - while others pay a premium, and return a surplus to the government.

The East Coast route is long and technically complex, and costs the state-owned infrastructure operator Network Rail a lot of cash to maintain, so the government will want to ensure the operator can cover a fair chunk of those costs to reduce the burden on the taxpayer.

But at the same time, the DfT will need to be careful not to overburden the next operator with premium payments, forcing this costly cycle of failed privatisation to repeat itself in a few years’ time.

How carefully a balance between high enough income for the government, and low enough costs for the operator, can be struck remains to be seen.