Branson: Behind the Mask (30 page)

Tony Collins expected problems. Speaking regularly to officials at the Department for Transport, the Virgin Trains chief executive sensed Whitehall’s cool attitude towards his company. Their misgivings, he knew, were sparked by his own success. Over the previous years, Collins’s protracted negotiations with officials had usually ended with Virgin extracting an advantage. The bureaucrats’ irritation was aggravated by Collins’s exploitation of their own incompetence, illustrated by one episode in 2009.

Collins had arrived at the department to set out a proposition. ‘Virgin’, he said, ‘will invest £100 million in additional carriages for the Pendolino trains if you extend the franchise by two years.’ Collins’s proposal was not a surprise. The media, briefed by Virgin’s publicists, had already reported the company’s plan to generate an additional £100 million in revenue every year if Whitehall granted its wishes. In Virgin-speak, the proposal was disguised as corporate generosity. By contrast, the department’s officials regarded the suggestion as a ruse to grab more profits, on top of the £98.5 million Virgin Trains had earned the previous year. After all, the extra carriages that Virgin wanted would, as usual, be financed by government grants. The department’s detailed scrutiny showed how, with the exception of ‘£5 million of improvements to a few waiting rooms’, Virgin’s £100 million ‘investment’ would be taxpayers’ money. Even the £5 million could eventually be recovered by Virgin from Network Rail.

The officials intended to reject Collins’s request, but as the
discussions dragged on their resolution faded. In the end, they surrendered and extended the franchise by a few months. ‘He’s rubbing his hands,’ griped an official about another Virgin victory.

The success came with a sting. Virgin had extracted government finance to add two carriages to each train. On the basis of Virgin’s promises, 106 carriages were ordered, but soon after their delivery Virgin rejected them. ‘We can’t afford to use them’, said Virgin’s director, ‘unless the franchise is further extended.’ His request was refused, and the new carriages were parked in sidings as testament to Virgin’s bullying of officials. They were also a tribute to Virgin’s technique. The operator had pleaded for more carriages to relieve overcrowding on the West Coast line. In reality, the line was crowded only during peak hours, when Virgin charged its highest rates. The taxpayer’s investment was wasted.

Branson’s self-portrayal as the good guy risking his personal fortune to modernise Britain’s railways was galling to officials who, since 2010, had cursed Virgin Trains for effectively negotiating a licence to print money. The combination of rebuilding the tracks, introducing Network Rail’s new timetable allowing Virgin to run more trains in peak times at high fares, and the government’s escalating subsidies had doubled the company’s revenue. Improvements masterminded by the Department for Transport and financed by taxpayers had doubled the number of passengers using the West Coast line. ‘He’s got a gold mine,’ said a senior official, reviewing Branson’s accumulation of about £381.7 million of profits over the decade – although the figures were never clear. Branson would say that Virgin Trains’ profits over fifteen years were £499 million but, according to the TUC, Virgin shared £519 million of profits with Stagecoach. The irrefutable truth was that after raising ticket prices by 9 per cent in 2012, Virgin’s profits ranked among the highest of the nineteen
train franchises and contributed to Britain’s railways costing 40 per cent more to run than those in the rest of Europe.

The high profits reaped from an unpredictable business were an accolade to the directors of Virgin Trains. Over the years, they had mastered the matrix of managing disruption, dropped loss-making services to Shrewsbury and Blackpool, and reduced the number of trains travelling to the north of England and Scotland. Consequently, at peak times, business passengers could rarely avoid paying the standard £296 return fare from London to Manchester. Those waiting on Friday evening at Euston for Virgin’s off-peak trains were held like cattle in pens near the platforms. Anyone mistakenly boarding a train with an underpriced ticket found themselves embarrassed by Virgin’s staff. By maximising the opportunities provided by Network Rail, Virgin’s profit in 2011 was £102.7 million, marginally down from a pre-tax profit of £105 million in 2009. Branson personally banked £17.8 million in dividends, and the company took an additional £40 million in government subsidies. Although in public Branson spoke about Virgin Trains paying the government ‘£100 million’, he forgot to mention the subsidies and profits the Virgin Group received simultaneously from the taxpayer. The profits were not purely cash. The Virgin brand benefited from sleek trains decorated with the Virgin logo racing across the country. Abroad, Branson quoted Virgin Trains as proof of his importance. In America, he mentioned his train company as his qualification to build a $2.6 billion high-speed train line between Tampa and Orlando; and during a visit to India, he said that he would ‘love to help’ establish high-speed trains in the country: ‘I have the experience to upgrade a crumbling network. In Britain we took over a dilapidated part of Britain’s network fifteen years ago and transformed it.’

The guaranteed profits and the opportunity to pose on engines for photographers roused Branson to plan his tactics
for the renewal of the West Coast franchise in 2013, following the extension from 2012. To tilt the odds in Virgin’s favour, he visited Theresa Villiers, the new Tory transport minister. In the passengers’ interest, he told Villiers, the government should grant a long franchise in order to benefit from Virgin’s investment and experience. She should, he advised, ignore the impossibility of accurately predicting future revenues over the length of a thirteen-year contract, and also the certainty of disruption if construction started at Euston station for HS2, the high-speed train. Villiers accepted his argument.

In anticipation of his bid, in December 2011 he hosted a party on the concourse at Euston station. Virgin Trains, he told his staff and passengers, was Britain’s most popular long-distance operator. In the National Passenger Survey, he said, the company had scored a 90 per cent satisfaction rate, partly thanks to his personal involvement. One particular advertisement featuring Branson had been praised by his publicists for generating an additional 1.8 million journeys. His guests applauded. Few realised that Network Rail’s operational performance tables showed the opposite. Every year, Virgin ranked among the worst operators for punctuality and attracted the highest number of complaints. The company naturally disputed those statistics. Other surveys showed that when Virgin trains were late, many passengers blamed everyone except Virgin, but for identical breakdowns on other services passengers heaped the blame on the train operator. ‘It’s the Virgin halo effect,’ moaned Branson’s rivals.

Virgin, Branson told his guests at Euston, had introduced seventy new trains at a cost of £1.5 billion, and hundreds of millions of pounds would follow in his continued effort to please his customers. The guests cheered his self-congratulation for ‘investing in innovation and quality’. No one mentioned that the billions of pounds were not Virgin’s but taxpayers’, and in
turn Branson did not mention that his profits in 2012 would be £43 million, albeit slightly down on previous years because the Department for Transport was clawing back £160 million. Even though his income from trains was falling, he wanted the new franchise. He understood the difficulties. Virgin had lost the bid for the East Coast line in 2006, and there was no certainty that Tony Collins could accurately anticipate his rivals’ bids. To calculate the winning sum, Collins hired Paul Furze-Waddock as development director. Furze-Waddock, a master of railway finance, would be expected not only to number-crunch but also to pick up clues inadvertently revealed by civil servants.

During their regular visits to the department’s headquarters, Collins, Furze-Waddock and Patrick McCall, Virgin Trains’ chairman, discussed the requirements for bidding. Their discoveries were revealing. To save money, the department had decided not to employ Grant Thornton or PricewaterhouseCoopers, the accountants, to scrutinise their own calculations. This was to be a fatal decision by the department. After years in the railways, Virgin’s directors knew that the department’s staff lacked the expertise to master the mathematical modelling. To cut overheads, the department had also reduced its staff. Among the departures was Mike Mitchell, the director of railways. Collins would not lament the retirement of his adversary: Mitchell was not only a shrewd operator but had been previously employed by FirstGroup, Virgin Trains’ principal competitor. In Whitehall’s games of musical chairs, Mitchell’s job was divided between three people, with Peter Strachan the man now overseeing the bidding process. Known as ‘a great guy in the pub’, he had a reputation for chairing long, inconsequential meetings and had abruptly resigned from another rail company after Mitchell had become his boss. Mitchell had turned the operator’s losses into profits. Among other departures were the department’s most experienced commercial managers. Some were hired by Virgin
to monitor how their replacements grappled with the complications introduced into the bidding process by Villiers.

One of the department’s critical tasks would be to assess the risk of a bidder failing to fulfil the thirteen-year contract. The calculation would produce the financial guarantee – the so-called Subordinated Loan Facility (SLF) – which the operator would be expected to pay in event of failure.

In February 2012, Furze-Waddock was quietly told by an official that the mathematical model the department was using to calculate the SLF was flawed. Furze-Waddock made a note of that telephone conversation. Pertinently, none of Virgin’s rivals heard the same information, and by chance the company found itself in a privileged position. In further conversations, Virgin obtained a special concession which was not discussed with rival bidders. The information involved the government’s calculation of the income a train operator could expect to receive from passengers. The figures appear in the ‘Passenger Demand Forecasting Handbook’ (PDFH), but only Virgin reached an understanding that the revenue from fares would not be ‘risk adjusted’. On that basis, Furze-Waddock recommended that Virgin could afford to submit a low bid and still win. Subsequently, he would claim that ‘Virgin was pushing the boat out with a very risky bid, offering even more than FirstGroup in the first years.’ Analysis of the bids would later cast doubt on that belief.

During more conversations in March, Virgin’s directors heard that the rules about the PDFH calculation had been amended, and asked for clarification to solve the confusion. In reply, an official explained that the department would not release more information about the PDFH or about the SLF because the department’s methods were ‘very basic and open to challenge’. Leaks to Virgin about the deteriorating situation within the department’s franchising group confirmed that the committee
responsible for the process was in disarray. Strachan was providing questionable leadership.

That was no surprise to Patrick McCall. At Easter, he had received a letter from the department describing how a company’s resilience would be judged by the operator’s reaction to the PDFH. Soon after, during a visit to the department, McCall was told to disregard the letter. Then, minutes after leaving the building, he was telephoned and told the letter was accurate after all. Furze-Waddock made contemporaneous notes about those contradictory calls. None of Virgin’s rival bidders, including FirstGroup, enjoyed similar access to the officials or became aware of the confusion across the department. Subsequently, the competing companies would complain about their perceived disadvantages.

On the eve of the department’s critical meeting in March to begin the decision process, Furze-Waddock realised the officials’ weakness. ‘We’re putting up issues they can’t solve,’ he reported. ‘Our modelling is better than anyone else’s, and the officials hate us because they can’t answer my questions.’ In anticipation of problems, Furze-Waddock and the Virgin directors warned the officials, ‘You’re doing it wrong’ and their mistakes ‘would lead to a protest’. At a meeting on 21 March, the same officials decided to ignore the possibility of the bidders challenging the department in court.

On 27 June, ten officials met to award the franchise. Inexplicably, Peter Strachan was not present at the Contract Award Committee, and the department was subsequently criticised for failing to give a satisfactory reason for his absence. The department’s assessments had concluded that FirstGroup was the outright winner. FirstGroup had offered £5.5 billion for the thirteen-year franchise against Virgin’s £4.8 billion and promised to invest more money to match bigger ambitions and produce more revenue for the taxpayer. With an agreed rate
of inflation added over thirteen years, FirstGroup’s offer was £13.3 billion against Virgin’s £11 billion. Critically, both operators had predicted identical passenger revenues and growth in the first ten years. But in the last three years, Virgin forecast no further growth, while FirstGroup predicted a continued upward trend. Over the previous decade, the number of passengers on Virgin Trains had grown by about 10.2 per cent every year. FirstGroup assumed that the annual growth would continue at 10.4 per cent, the same figure used by the government to justify the construction of HS2.

To attract more passengers than Virgin, FirstGroup intended to reassign many first-class seats to cheaper fares; add extra carriages to popular trains; reduce fares; and reintroduce services to Blackpool, Shrewsbury and other towns that Virgin had abandoned. In summary, the company proposed to offer an additional 12,000 extra seats every day and eleven new trains, including the 106 new carriages unused by Virgin. To make the service more attractive, FirstGroup also proposed to enlarge the catering service. Virgin had bid conservatively in order to match the assurance Furze-Waddock received that the government was not expecting any operator to take risks. Accordingly, Virgin was outbid and FirstGroup was the winner. The remaining issue was the cash guarantee, or SLF, based on the forecasted revenue. FirstGroup’s risk was calculated at £215 million, while Virgin’s bid was so low that its SLF was assessed as zero.