5.18 We then considered what efficiency adjustment to apply. We had evidence from studies by CEPA, Oxera, Civity, BDO/CEPA and Willis. Compared to PR08, we have completed a more wide ranging set of studies on support costs. These studies are summarised below and each study, or an executive summary of the study, is available on our website141.
5.19 Figure 5.1 sets out the three main options for determining Network Rail‟s efficient support costs in CP5.
Figure 5.1: Options for determining Network Rail’s efficient support costs
5.20 We have based our assessment of Network Rail‟s CP5 support costs on the
combined/hybrid approach. This means that where Network Rail has provided robust analysis of its functions‟ costs, we have used Network Rail‟s forecast of costs.
However, where Network Rail has provided insufficient justification for its forecasts, we have applied a top-down efficiency assumption to our view of Network Rail‟s pre-
efficient costs. We have done this for information management, insurance and other Corporate Functions.
5.21 Our top-down efficiency assumption has been calculated by taking the average of CEPA‟s forecast of 4.4%142(the CEPA study is summarised below) and Oxera‟s
forecast of 3.0%143 annual efficiency estimates. We recognise that the use of a top-
down efficiency assumption is subjective, so by taking this approach we have made our final determination more robust.
Top-down comparison of Network Rail’s support and operations costs against other companies (CEPA)
5.22 The purpose of CEPA‟s study was to provide estimates of Network Rail‟s scope for achieving efficiency gains in support and operations costs over CP5. This study drew on the historical performance of other UK network industries and different sectors‟ productivity performance in order to determine the possible scope for efficiency gains for Network Rail in CP5. CEPA used the following methods to provide a range for the scope for efficiency gains: Real Unit Operating Expenditure (RUOE); Total Factor Productivity (TFP); and a Labour, Energy, Materials and Services cost measure (LEMS).
5.23 CEPA found that, subject to Network Rail delivering its CP4 targets, the average annual change in RUOE of 4.4% (for comparator industries in their third price control144), and the LEMS cost measure for electricity, gas and water supply
(11-15 years since privatisation) of 5.1%, could represent an appropriate annual target for each year of CP5. Savings of this order are consistent with broader studies of Network Rail‟s relative efficiency, e.g. the benchmarking work included in the RVfM study, which suggested that Network Rail‟s costs are significantly higher in a range of activities than those of its international peers145.
International support and operations benchmarking (Civity)
5.24 We commissioned consultants, Civity, to benchmark Network Rail‟s support and operations expenditure against other railway infrastructure managers. The aim was to help us to understand whether, and to what extent, there is a gap between the
142 We commissioned CEPA to produce a study on the scope for Network Rail to achieve efficiency
gains in operations and support costs in CP5. This is available at: http://www.rail-
reg.gov.uk/pr13/PDF/cepa-orr-om-productivity-over-cp5.pdf.
143 Network Rail included a study by Oxera on the scope for efficiency improvements in Network Rail in
its SBP.
144 CEPA based its assumptions on the third control period because it assumes that when Network Rail
took over its responsibilities, the effect of Railtrack‟s problems had reset efficiency levels to the level at privatisation. Therefore, as CP5 is the third control period after Network Rail took over its
responsibilities, CEPA‟s analysis was based on the efficiency levels in comparator industries in their third control period.
145 These results are similar to the analysis that Oxera carried out for us in PR08. Oxera‟s PR08 study
efficiency of Network Rail‟s support and operations expenditure and that of
comparators (particularly the most efficient rail infrastructure managers). Civity‟s views on operations costs are included in the operations expenditure chapter (chapter 7). 5.25 For support costs, Civity found that, in relation to its peers (based on total
expenditure, staff size, and labour costs), Network Rail's total expenditure on support functions (representing 8% of its total annual expenditure) is in the middle of the peer group. Civity also found that this was the case for individual support functions, with the exception of procurement, where Network Rail‟s position is at the higher end of its peer group.
5.26 However, Civity did conclude that the current positioning of Network Rail relative to its peers cannot be used to draw reliable conclusions on Network Rail's efficiency and that further disaggregation of costs would be necessary to produce more reliable analysis. We consider that this study has identified a number of useful issues but we have not used it to inform our determination of support costs for CP5 due to the issues over data reliability highlighted by Civity.
Pace of change study (BDO/CEPA)
5.27 The purpose of the study was to develop a greater understanding of the potential pace of change for the cost savings that Network Rail could achieve in its support functions over CP5. The study considered a number of companies and reviewed how they reacted to significant changes to their businesses, e.g. from mergers, regulatory change through a price control and changing markets. The study also sought to estimate Network Rail‟s fixed and variable support costs and determine how the split between fixed and variable costs can impact on a company‟s ability to react to a significant business change, e.g. a merger, acquisition or price control.
5.28 The study found that major change within other organisations can often be seen first in support costs, with significant cost reductions achievable within two to four years, although this was potentially more difficult to sustain in the long term. The study also found that where there is a significant business imperative, e.g. potential bankruptcy, the pace of change is at its most rapid and most extensive. When reflecting on
Network Rail‟s current position, the report concluded that Network Rail‟s historic pace of change in support costs has been slow and steady and that there was scope to increase the speed at which Network Rail implements its change programmes. 5.29 We did not use this analysis directly, but it provided an important sense check on the
appropriateness of the use of the top down efficiency average. Given the overall challenge of our PR13 package we consider that the speed at which we are assuming costs savings can be made in this area is reasonable.
Insurance costs (Willis)
5.30 We commissioned Willis (an insurance broker) to review Network Rail‟s proposed annual insurance costs for each year of CP5 to consider whether Network Rail's
are efficient, e.g. are there some risks that Network Rail could manage more efficiently than it is proposing?
5.31 Willis concluded that Network Rail‟s overall approach to insurance costs is efficient. However, it identified some aspects of Network Rail‟s insurance cover where Network Rail may not take an efficient approach, e.g. terrorism insurance.
Network Rail studies
5.32 In support of the IIP, SBP and as part of progressive assurance, Network Rail has commissioned a number of external and internal studies. We have considered the findings of these studies in our assessment of Network Rail‟s CP5 support costs. 5.33 These studies included:
(a) Oxera study on the scope for efficiency improvements in Network Rail in its SBP; (b) Hackett benchmarking of key support functions, e.g. HR;
(c) IPD workplace management benchmarking; (d) Gartner study on information management; and (e) Arup review of NDS.