This article first appeared in The Institute of Water
The extension of competition in water and sewerage services in the non-household (NHH) retail market is going to bring a period of unprecedented change to the water industry. As a result, companies need to take some critical decisions now if they are to adapt successfully to this new world.
From April 2017 all businesses in England will be able to choose their water supplier. This is a major change, increasing the number of premises that can switch suppliers from 27,000 to approximately 1.5 million.
More significant, is the fact that this is just the start, with further competition signalled. Following the Treasury’s announcement in November 2015 about the possible introduction of household competition, Ofwat is currently undertaking a Cost Benefit Analysis. In addition, the recent consultation on Water 2020 has provided the clearest indicator yet of the general direction of policy and the intention to introduce competition across the industry value chain (abstraction, sludge treatment).
This means that water companies need to begin to respond proactively to these changes and prepare for a market that will look very different. The Severn Trent/United Utilities retail joint-venture, announced at the beginning of March 2016, suggests that some parts of the industry are waking up to the real implications of change and taking proactive steps to prepare their business for the future.
All companies now need to take some clear sighted decisions about their approach to competition and what position they want to take in the new market. Essentially they need to choose whether to respond to the minimum requirements required to comply and then see what happens; actively decide to compete; or to consciously opt out of the NHH market (i.e. to exit).
Waiting and watching
In coming to these decisions, it is important to recognise that the introduction of NHH competition will require a shift in the old ways of doing things. In particular, it will bring a requirement for greater commercial expertise. In an industry where the customer has been historically bound to a single supplier those skills have traditionally been less important but that will change – and rapidly so.
The new world will also bring along separation of fully integrated companies into different separate businesses. Although this presents real challenges for business leaders, because it is unlikely to have a significant impact on short-term revenue there is a temptation to avoid responding or taking action.
In this context, standing back and seeing how the new world develops can seem an attractive option. Clearly it will take time for the market to develop and there will be initial turbulence; early entrants will face some uncertainty. So there is a credible argument that companies with little experience of competition and concerns about the financial implications should not be plunging straight into the competitive fray. However, there are potentially significant downsides to this passive approach.
The first of these is that, while there may be some short term challenges, those who are involved from the start will have the experience to draw on once the market stabilises. That will strengthen their position over the medium term. The second drawback of standing on the side-lines is that if regulators do open up more of the sector to competition, both household and upstream, then companies will have to deal with potential changes in revenue streams in any case.
Given the nature of the policy debate and the clear indications of support for further competition, it seems inevitable that there will be further change and so companies will need to secure the skills they need to deal with it. Any delay in acquiring that commercial expertise and outlook caused by standing back now is likely to be a significant disadvantage when more competition arrives.
Deciding to compete
So the risks of doing nothing are significant, and underline that companies do need to actively consider their strategies and approach to the changes. In particular, if they do decide to compete they need to choose how they are going to do this.
The most straightforward approach may seem to be to focus on current customers. Yet the reality is that those customers will be seen as targets by competitors and some of them will inevitably be lost over the medium term. As water retail businesses have proportionally higher fixed costs, losing customers could have significant financial implications. So companies will need to look beyond their existing base to attract new customers, to maintain an appropriate cost to serve.
In order to do this, they will need to offer an attractive proposition. That means there will need to be a careful assessment of the company’s processes and customer service, as well as the prices they charge. It will require a focus on ensuring the highest quality performance and a willingness to develop different services and new relationships with customers, based on the understanding that if they are not satisfied they will be able to go elsewhere.
Developing that offer to customers should reflect decisions about which groups the company is going to target. They do now have the advantage of being able to use the extensive customer group and tariff data that Ofwat published as part of the PR14 process. This should make it easier to take informed decisions about the costs and benefits of targeting and acquiring key customers or specific groups of customers. Deciding to compete is a major step and must be predicated on the likelihood of competing successfully in the non-household retail market, at the necessary scale.
While this is a very new world, there are some lessons to be drawn from others. The experience of the electricity or Scottish water markets offers some insights. Equally, retailers have learned a lot from changes in their own market and that means they have some commercial expertise which they may very well apply to the retail NHH market and look to target incumbent companies’ customers.
In making decisions about their future strategy, companies need to recognise that competing successfully in the non-household retail market will prepare them for the potential competition in the household market. That will be an even bigger challenge not least because the scale of the market means that the stakes are higher. Being prepared will be a real advantage.
The attractiveness of the household market also means that the competition will be fiercer. The major utility companies are more likely to be interested in entering the market, in order to provide a ‘one stop shop’ to their customers and take full advantage of economies of scale. That means that for existing water industry incumbents, it is likely to be a case of getting big or getting out.
The implications of exit
Even if companies decide not to participate in the competitive NHH retail market then they still need to make rapid decisions to address its implications. While the volumes of business involved are relatively small, the largely fixed costs companies have to manage mean that any decision to exit the NHH retail market could increase the costs of serving the household market.
This, in itself, does not mean this is the wrong decision. Coming out of the NHH market could ensure that the company is better focused on their core business and avoid having to divert time and resources to an area that may not be part of their longer term strategy. However, whatever decision they take it will have a long term effect on the overall business and so they need to be sure that they have considered all the options carefully, taking into account the full financial, regulatory and operational effects.
It is clear that in the longer term, it could be tough to prosper in the water retail market if the industry develops as predicted. This places a heavy burden on leaders to make the right decisions and these decisions must be based on a clear understanding that it will not be business as usual in the future.
There is a real urgency to these decisions. It is now less than a year until the new framework is in place and options will close off as we get nearer to April 2017. However tempting it might be to wait and see what happens, the challenges of the new world mean that this will not be a successful long term strategy. Action is needed and it is needed now.
Stève Hervouet and Keith Gardner are water experts at PA Consulting Group. Steve Frobisher is business strategy expert at PA Consulting Group