Network Rail races to slash costs as bonuses dispute looms

Network Rail's profits dropped by nearly 75 per cent last year, but the company says it is on track to make the stark savings demanded by its regulator over the next four years.

The railway infrastructure group's annual results were published the day after a warning from the Office of Rail Regulation (ORR) that "significant weaknesses" in performance over the past year threatened Network Rail's ability to meet required budget cuts of 21 per cent from 2009-14.

Network Rail is a quasi-independent company, with no shareholders and most of its funding from the Government (see below). It says it has made £265m of efficiency savings over the past year, a 5.8 per cent reduction on the previous year's costs – and has a clear plan to deliver the rest needed to stick within the ORR's five-year budget for Network Rail.

The chief executive, Iain Coucher, stressed the company's progress yesterday, saying: "It has been a good year for Network Rail, particularly on the measures that are important to customers. We are not perfect and there are areas where we can improve, but we have had no major overruns, we've put fewer people on buses and have cut the cost of running the railway."

Network Rail blamed a fall in profit for the year to 31 March, from £1.52bn to £395m, on the ORR's stricter revenue regime and rising costs, including £50m of upfront redundancy payments. Revenue dropped by 8 per cent to £5.7bn – pushed down by the ORR's determination to reduce charges to train operating companies by 7 per cent to £1.65bn. For the 2009-14 "control period", the ORR determined that Network Rail will receive £30bn for work that would have cost £35bn under its previous cost structure. Of the £265m in savings made over the first 12 months, £85m came from reduced maintenance costs and £160m from cuts in supply chain spending.

Network Rail has faced a challenge reducing its staff costs. It cut 500 jobs last year and another 700 will go this summer. It has also faced strident opposition from the Rail, Maritime and Transport (RMT) union over plans to change shift patterns for maintenance staff to include more night and weekend working.

A strike ballot was overturned in the courts but Mr Coucher said there had been a breakthrough in recent talks. "We have sat down with the trade union in the last 10 days and entered a more constructive phase of negotiations," he added. "Hopefully we can resolve the situation in the next few weeks without any strikes."

But Mr Coucher was non-committal in response to the ORR's criticisms earlier in the week, claiming that the doubts cast on Network Rail's ability to meet its five-year efficiency targets were to be expected only one year into the period.

"There are tough efficiencies to make and the regulator is always going to air scepticism because we haven't yet delivered it all," he said. "But we are confident and we have a delivery plan that lays out how we will do it."

Mr Coucher refused to be drawn on the issue of bonuses, which was also raised by the ORR. Network Rail has drawn fire in the past for its bonus structure, which its defenders claim is a necessary incentive for executives in the absence of shareholders.

The rail watchdog said this week that the company's "mixed" performance – notwithstanding punctuality rates up to 91.5 per cent from 90.6 per cent last year – should be taken into account when setting bonus levels for executives this year. Mr Coucher said Network Rail would report separately on the issue of bonuses at the end of this month.

Thus far, the new Government has given no indication whether much-needed public spending cuts will hit Network Rail's funding. The expectation is that any scaling back will affect projects still in the pipeline – such as the electrification of the Great Western main line – rather than the upgrade and maintenance work already scheduled.

"We have a price set by the regulator for the service the Government wants to buy, which includes quite challenging efficiency savings," Mr Coucher said. "But we are mindful of the situation and if the Government needs to find different ways to do things or different phasing for what is planned, then we will look at that."

Moving on from Railtrack

Network Rail is an unusual hybrid – with no shareholders and very little exposure to market fluctuations – that was created in 2002 from the ashes of Railtrack, the discredited attempt to privatise what had been British Rail's infrastructure business.

As the successor to Railtrack, Network Rail owns almost all Britain's rail network, including 20,000 miles of track, 40,000 bridges and tunnels, and 2,500 stations, of which it operates 18 of the largest.

A "company limited by guarantee", its directors are held accountable by a 100-strong board of members who serve three-year terms and are appointed from across the rail industry and the general public.

Membership is conferred by an independent panel and comes with a duty to act in the best interests of the company with no remuneration beyond travel expenses.

Only a sliver of the group's income is self-generated. A third of its revenues come from the fees charged to train operating companies and freight carriers, at levels set by the Office of Rail Regulation as part of each five-year "control period".

The remaining two-thirds of Network Rail's funding comes directly from the public purse. For every control period, the ORR sets the price that Network Rail can charge the Government for the work it will do, including day-to-day operation and maintenance, and major infrastructure upgrades.

"We are a fixed-price contractor to the Government," Network Rail chief executive, Iain Coucher, said.