The claim:

“If we thought we could get 10 per cent year on year growth, we would have bid 10 per cent year on year growth. We don’t believe that’s possible…there’s a lot of discretionary travel on West Coast and people can go other ways – cars, aeroplanes and so forth. It doesn’t take much to lose your five per cent revenue base.”

– Virgin Rail Group chief executive Tony Collins, 15 August 2012

The background:

It’s been a bombshell day for Virgin today.

This morning’s news that the company has lost its bid to continue running the West Coast mainline in favour of FirstGroup, who have been awarded the new contract instead, has been met with nothing short of dismay by Virgin and its staff.

Sir Richard Branson has threatened to pull out of the railways altogether, and the chief executive Tony Collins described today as “probably the saddest day” of his professional life.

At stake, is a bid for the lucrative line – one of Britain’s most profitable, which was run by Virgin since 1997. FirstGroup bid £5.5bn over the 13 years of the agreement. Had an extension been agreed, they’d raise it to £6.1bn. There were also £250m in guarantees for the right to operate Intercity west coast services, and £390m in premiums each year.
Virgin’s bid was at £4.8bn over the term, rising to £5.4bn with the extension. They now pay £160m in premiums.

Explaining the bid, Sir Richard said he didn’t want to “risk letting everybody down with almost certain bankruptcy at some time, as happened to GNER and National Express who overbid on the East Coast mainline.”

Chief executive Tony Collins then went on to explain that FirstGroup’s revenue base of 5 per cent was too narrow a margin, as passenger numbers were too flexible.

The analysis:

The big question at the heart of the bid is passenger numbers. As one Virgin source told us: “Revenue growth is dependent on passenger numbers.”

According to the FirstGroup press release, revenues on the franchise for the last 10 years – under Virgin – were at an annual growth rate of 10.2 per cent. They say they hope to keep annual revenue growth rates at 10.4 per cent, “supported by passenger and revenue focused operating investment and backed by substantial capacity increases”.

It didn’t wash with Virgin. Our source said: “We’re concerned that the bid is over ambitious…the concern is that there won’t be enough passengers to get that growth.”

Looking at passenger numbers in the last couple of decades or so, the biggest hike came after privatisation.

Figures collected on passenger journeys from the Office of Rail Regulation show that since 1993, passenger numbers have risen consistently every year, until 2009 to 2010 when they dipped, but then rose again.

The Hatfield rail crash in 2000 did have an effect on numbers, and slowed them down. But there certainly wasn’t any decline.

Over the last 10 years, rail passenger numbers have increased at varying rates, from around 2.7 per cent a year, to the last couple of years, in which numbers have soared by 7.8 per cent last year. There were a total of 1,460m passenger journeys on franchised routes last year.

In fact, despite the banking crisis of 2008, rail passenger numbers are still strong, and only show signs of getting stronger, according to the Independent Transport Commission.

They say that train travel is likely to be well on track for the next 20 odd years.

Even taking into account rail fare rises, they say, they’ve carried out research which says they expect rail travel to increase by 35 per cent.

If there is a change in government policy and fares are capped, they say that rail travel could jump by as much as 60 per cent.

In fact, they consider that other factors, such as the way that car travel is becoming less and less attractive, may even boost rail travel further. They predict that rail travel will grow more quickly than car travel.

Likewise, if rail travel becomes more efficient, reliable and convenient, it’s likely to continue along the trend it’s been following for the last 15 odd years.

The verdict:

Virgin’s bleak outlook on FirstGroup’s ability to run their former rail line is understandable – as they say, previous bids by GNER and National Express failed to deliver.

And there is a chance that their business performance may not live up to what they expect due to other reasons – capacity, cost of raw materials, changes in fuel costs, or other overheads.

But based on passenger numbers, the experience of the last 20 odd years doesn’t show many signs of changing, and research suggests it’s likely to improve, not worsen.

Yet as our Virgin source told us: “For the sake of the railways, we hope FirstGroup are right.”

By Fariha Karim