ORR market study on signalling projects: Green-lighting competition or railroading innovation?

December 2021

Paul Henty and Ellie Eastwood

Introduction

On 8 November 2021, the Office of Road and Rail (“ORR”) published its long-awaited market study report. The ORR is aiming to take measures to open up the railway signalling market. It wishes to allow Network Rail (“NR”) to boost competition between suppliers on cost, quality and innovation, and drive greater efficiency and performance across the network.

The move is significant given the critical importance and value of signalling equipment in the rail sector. NR’s annual signalling expenditure is in the region of £800-900 million p.a. representing over 10% of its total cost base. The ORR’s report expresses a high-level concern that the cost of signalling projects are too high and that ineffective competition is partly to blame.

Two suppliers in particular enjoy disproportionate market power and this may be distorting competition in the market. In the ORR’s view, while NR is the owner and infrastructure manager of most of the railway network, its market power may not be enough to discipline these two owners of “must have” rail technology. It is estimated that within the ensuing 15 years, around 65% of all signalling infrastructure will need to be replaced. There is a desire to make the rail system fully digital, which will require heavy expenditure. That should take place in an efficient market structure.

This note looks at the backgrounds, the key findings reached by the ORR and the next steps in the regulatory process.

Background to the inquiry

The railway sector in the UK is characterised by one organisation being responsible for the maintenance of rail infrastructure in the UK. Signalling is a critical part of that infrastructure, ensuring that rail traffic moves safely and efficiently.

Signalling systems are made up of several different components. One of the most safety critical is interlocking equipment. Interlocking equipment controls the route of trains and vehicles within stations or at depots to ensure safe movement. Any interlocking equipment used on British railways will need to be trialled by a willing sponsor (which must usually be a NR Rail Access Manager). That is a long and arduous process which makes the introduction of new equipment onerous and costly. Would be entrants are usually unlikely to have a bank of signalling project work to pay for the investments made, which is likely to deter them from making the investments required.

British Railways (“BR”) developed Solid State Interlocking (“SSI”) for use on the GB network in the mid-1980s. Following the privatisation of BR, the right to develop and deploy SSI passed to two companies. Through acquisition, the rights to SSI are now owned by Siemens SA (“Siemens”) and Alstom AG (“Alstom”). This gives those companies a strong position in the signalling market; the ORR found that they had been awarded places on every major signalling framework awarded by NR since 2004.

Beyond interlocking, other important components of signalling systems are identified in the ORR study. For example, control systems are also vitally important. Originally, alongside SSI, BR developed the Integrated Electronic Control Centre (“IECC”) – a control system consisting of a computer workstation to aid signallers in setting routes. Three companies own control systems currently deployed on the GB mainline: Alstom, Siemens and Hitachi.

Catalyst for enquiry: Alstom-Siemens merger

In 2018, Siemens and Alstom proposed to merge. The scale of the transaction was such that regulatory approval was required from the EU Commission under the EU Merger Regulation. Ultimately, the EU Commission blocked the deal, citing a number of serious concerns relating to competition in national rail markets across the European Union, specifically in relation to shares of segments involving the supply of rolling stock and signalling equipment.

In its consultation process with third parties which led to this decision, the ORR voiced a number of serious reservations about the combination of the two entities. The ORR considered that the two organisations would control around 75% of the British rail signalling market. For some specific elements of signalling, such as interlocking, their share would likely be even higher. The ORR estimates that a merger could increase costs by tens of millions of pounds each year because of reduced competition.

ORR market study

One of the ORR’s functions is to act as competition regulator for the rail sector, a power it holds concurrently with the Competition and Markets Authority (“CMA”). One of the specific powers it has is to conduct market studies into sectors where competition may not be working well.

The ORR first announced in April 2020 that it was opening a study into the signalling market. The move followed on from its intervention in Siemens – Alstom and the representations it made in that case.

Nature of signalling products and projects markets

An important feature of a signalling system is the way in which components are integrated (components may be integrated into the network via a series of processes such as design, installation, and testing). In recent years, the process of integration and overall project management has increasingly been passed to suppliers, rather than being retained by purchasing infrastructure managers.

This means that effectively there are two separate markets in the view of the ORR: a market for signalling products and a market for signalling projects. Signalling products form an upstream input for those undertakings downstream engaged in integrating activities. The ORR illustrated market structure as follows:

The ORR has noted that Siemens and Alstom are the owners of the two dominant interlocking product solutions. The two companies account for an increasing share of NR’s signalling spend (rising from c.70% in 1999-2004 to c.90% in 2019-2024). The ORR further found that whilst rivals had – to some extent – succeeded in competing as integrators with the two incumbents, they had been unable to build on initial success.

Findings of study

The ORR has reached the following conclusions:

Significant barriers to entry to the UK signalling market – Stakeholders pointed to the considerable cost and effort required to be able to compete in the UK. This includes the need to obtain product type approval for new technologies. The ORR found a “catch 22” situation – businesses were unwilling to make the sizeable investments without a visible and predictable pipeline of work to compensate for it. They reported that it was difficult to make a business case to bring online new technology when they were contracted to NR under “zero value” frameworks.
Outcomes – The ORR concluded there was a direct correlation between competitive procurement structures and the cost of projects. It noted projects had turned out more expensive in single party frameworks or where direct awards had been made.
Digital railway – Whilst many elements of existing UK rail infrastructure are already digital, there is still some way to go in terms of replacing all conventional signalling equipment (such as lineside technology) for more modern, digital tools (such as in-cab technology). At current levels of expenditure, this goal is out of reach.
Introducing new technologies – There are inherent barriers to introducing new signalling products, such as the need to comply with national signalling rules and find a sponsor (usually a NR regional manager) willing to trial it on a new project.
Interfacing technology with the existing base – NR is required to ensure that the network as a whole will function coherently. NR wishes to foster long-term competition but at the same time has experienced practical difficulties from maintaining a number of different technologies simultaneously. The ORR identified that in NR procurements it had previously gone so far as expressing preferences for a particular supplier’s technology with the aim of ensuring a smoother interface with other parts of the installed base.

Proposed remedies

The ORR had the option to refer the matter to the Competition and Markets Authority (“CMA”). In May, the ORR confirmed that it would not make a referral to the CMA which would have allowed it to make a market investigation. The CMA has a range of legal powers to correct failures in a market which is considered not to be working well for consumers. One of the tools in the CMA’s arsenal is the ability to force businesses to divest assets. Alternatively, it may have been able to order certain undertakings to provide access to key technology on terms which were fair, reasonable and non-discriminatory.

The ORR considered the exercise of such powers to be disproportionate. Instead, it has opted for more structural remedies, much of which focus on the purchasing power of NR and the way it commissions its projects. More specifically, the ORR has proposed the following remedies to address the challenges it identified in its study:

Remedy 1 – Increased regulatory oversight: recommendations aimed at enhancing monitoring of the market and increasing transparency over costs, delivery, volumes and market shares. This will involve action from both the ORR and NR with strengthened oversight of such variables as prices and costs of signalling renewal, volumes and market shares.
Remedy 2 – A pro-competitive approach to procurement: recommendations addressed to NR aiming to reward pro-competitive behaviour, widen the pool of suppliers, and reduce NR’s dependency on the two prominent suppliers of signalling technology. The ORR notes that NR’s market power is disproportionately small to its status as a near monopoly purchaser in the market. If either of the two dominant suppliers were to withdraw from the GB market, that would create very significant problems for its signalling renewals program.
Remedy 3 – Interfacing: these are recommendations addressed to NR aimed at ensuring interfaces are opened up and mechanisms for addressing concerns and complaint about interfacing and access to technology are effective. The ORR wants NR to treat open interfaces as a priority, given their potential to increase competition. NR must also strengthen its internal mechanisms for reviewing supplier concerns about interfacing and access to technology.
Remedy 4 – Balancing: these recommendations, addressed to NR, are made aimed at ensuring NR’s procurement processes are run on genuinely competitive terms and do not unduly favour existing suppliers or penalise first movers in new technology. NR is urged to engage with its regional divisions in promoting a greater awareness of competition concerns as well as incentivising the adoption by them of more innovative technologies.
Remedy 5 – Funding: This remedy will require dialogue between the ORR, NR and the Department for Transport. It makes recommendations aimed at providing suppliers with greater certainty in the volumes of work awarded to them and reducing the risk when developing new technologies. These include, for example, providing minimum guaranteed work levels for operators who win places on NR frameworks (as opposed to a number of existing “zero value” frameworks). There is also a recommendation of a new centralised research and development fund for innovative projects.

The ORR has invited NR to respond to the report within three months and to confirm its strategy and plan for implementing these recommendations.

Comments

Given the strategic importance of signalling and the significant share of the NR budget which it represents, it is unsurprising that the ORR made this a focus of its regulatory activity. The ORR is clearly concerned that the cost of signalling projects is too high and that ineffective competition is to blame.

Having opted not to refer the matter to the CMA, focus will shift to NR to see the strategy it unveils in response to the ORR’s market study. As noted in the ORR’s report, NR faces to some extent a tension between, on the one hand, a desire to ensure that different parts of the Network function safely and coherently and, on the other hand, introducing competition.

Whilst third parties may be frustrated that the ORR study does not go far enough, the report may prove a useful document should they wish to commence any private enforcement action (for example if they have a disagreement with either of the two incumbent suppliers when seeking a licence to their signalling technology). Where an undertaking is considered to be in a dominant market position, they may in certain circumstances be required to provide competitors with access to their technology under Chapter II of the Competition Act 1998 or Article 102 of the TFEU. The results of the market study will give ample ammunition to any party wishing to bring a claim that the established duopoly may be enjoying a considerable level of dominance in the rail signalling market.

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