4.102 This section outlines our specific assumptions in each area of expenditure, including the cross-cutting savings explained above.
Support
Background
4.103 Support costs include expenditure on activities that „support‟ Network Rail‟s business. These are mainly administrative costs, such as costs related to finance, but include other running costs such as utilities and insurance.
4.104 In its SBP, Network Rail set out its plan to deliver a 24% reduction in its support costs over CP5. This included cost reductions by the end of CP5 compared to 2013-14 costs of 12% in core support costs134.
4.105 Our approach to the assessment of Network Rail‟s support costs is set out in detail in the support expenditure chapter (chapter 5). In summary, we have decided on a base year and „rolled forward‟ costs for that year through each year of CP5 by applying an efficiency assumption. We have derived our efficiency assumption by applying a combination of both top-down and bottom-up approaches. Where Network Rail has provided robust analysis of its functions‟ costs, we have used Network Rail‟s forecast. However, where Network Rail has provided insufficient justification for its forecasts, we have applied a top-down efficiency estimate to our view of Network Rail‟s pre- efficient costs.
Responses to our draft determination and our comments on the responses to our draft determination
4.106 Network Rail‟s responses on support expenditure are included in the support
expenditure chapter (chapter 5) together with our comments on those responses. We received no other material consultation responses on support costs.
Our determination
4.107 Our assessment of efficient support costs for CP5 assumes that Network Rail can achieve efficiencies in core support costs of 20% by the final year of CP5 and a reduction in total support costs of 25% by the end of CP5. Overall there is a saving of £621m in CP5 compared to total CP4 support costs of £2,740m and £113m less than Network Rail‟s SBP assumption of £2,232m.
134 We are focusing on core support costs because we consider a comparison at that level provides a
Operations
Background
4.108 Operations expenditure is expenditure incurred in „operating‟ the rail infrastructure such as expenditure on signallers and control staff. Our approach to the assessment of Network Rail‟s operations expenditure is set out in detail in the operations
expenditure chapter (chapter 7).
4.109 Network Rail‟s SBP set out its plan to deliver a 13% reduction in operations
expenditure over CP5 primarily through the implementation of a new way to run its infrastructure, known as the network operating strategy. This strategy should reduce Network Rail‟s operations costs as it will reduce the number of signallers required to operate the network.
4.110 We have reviewed Network Rail‟s proposals against various domestic and European benchmarks. We have also conducted our own assessment as to whether the
strategy can deliver the proposed benefits. Network Rail will compare favourably with international benchmarks once the strategy is implemented. However, Network Rail‟s proposed costs for operations activities outside signalling are above benchmarks with other UK regulated industries. For our assessment of these non-signaller costs we have taken into account domestic benchmarks and savings from cross-cutting issues.
Responses to our draft determination
4.111 Network Rail„s main response on operations expenditure was that it does not think that it is appropriate for us to use a hybrid approach and apply our top-down efficiency assumption to operations activities outside signalling and to also apply the cross- cutting efficiency assumptions to those costs.
4.112 Network Rail compared the combined operations and support expenditure challenge of 24% to the CEPA and Oxera top-down average efficiency assumption of 17.2% and it thinks our assumptions are stretching. Network Rail also stated that we have not taken account of QX cost reductions in our forecast of QX income.
Our comments on the responses to our draft determination
4.113 We have considered Network Rail‟s concerns about our hybrid approach to our assessment. Network Rail has generally supported us in using more bottom-up analysis to support our assumptions. However, when we do not think its analysis is robust we can either develop our own bottom-up assumptions or use a top-down approach. By definition deriving a bottom-up estimate when we do not think Network Rail‟s plan is robust is not straightforward, e.g. it does not have a set of policies for how much money it should spend on information management, in the same way that it does for track renewals. There is also an asymmetry of information between us and Network Rail.
4.114 Therefore, when Network Rail has not provided a robust bottom-up analysis for a part of its business, we think that applying a top-down approach would be more
appropriate and the most important issue is checking that the efficiency assumption for that part of the business is reasonable and that the efficiency assumptions for operations expenditure overall are reasonable.
4.115 In relation to applying a top-down efficiency assumption to operations activities outside signalling. Network Rail has not provided adequate evidence to show that its assumptions are efficient or that our approach is inappropriate. We also note that the main cost of operations is employment costs and the IDS report found that Network Rail‟s operations staff were paid 36% above the market rate.
4.116 Network Rail noted that the total challenge on support and operations expenditure is higher than the top-down efficiency assumption derived from an average of CEPA and Oxera‟s analysis. However, CEPA and Oxera‟s forecasts are averages over a
significant amount of data from a number of industries, which Network Rail‟s comment does not seem to take account of, as it simply compares the average of CEPA‟s and Oxera‟s top-down efficiency averages to our overall assumptions on support costs, rather than considering the reasons for the differences.
4.117 For example, one of the main drivers of the cost reductions we have assumed in operations costs is the network operations strategy, which has a one-off effect for the areas where it is being applied. There are also significant one-off changes that
Network Rail is proposing in some areas of its expenditure that are included in
support costs but are actually more engineering related. Once those costs and group costs are excluded from support costs to provide a more useful comparison, the efficiency challenge is 20%, which is higher than the average of CEPA and Oxera top-down efficiency assumption of 17.2%, but lower than CEPA‟s own average of 22.0%.
4.118 Also, in response to Network Rail‟s point about QX, we have now taken account of QX cost reductions in our forecast of QX income. Network Rail‟s issues with cross- cutting issues are discussed above.
Our determination
4.119 Our assessment of Network Rail‟s efficient operations expenditure in CP5 assumes that Network Rail can achieve 17% efficiencies by the final year of CP5. This is a saving of £271m in CP5 compared to total CP4 operations expenditure of £2,239m and £59m less than Network Rail‟s SBP assumption of £2,027m.