This article first appeared in The Water Report
Prior to full competition, water companies had a straightforward way of setting their strategy and change approach. The business model was mature, the customer base was static and margin improvements could be made by exploiting technologies such as asset management GIS and CRM systems. But the landscape has significantly changed following the Water Act and hard decisions must now be made for the future.
Banks and efficient governance
Splitting a business into separate retail and wholesale activities is undeniably a complex operation. But it is a well-trodden path within the utilities sector and importantly in other industries too and water companies can learn from how those firms went about it.
In the financial sector, firms are currently implementing regulatory change to separate their retail arms from investment banking as part of the response to the 2008 world banking crisis. The regulator, in the form of the Prudential Regulation Authority (PRA), has not mandated separate programmes, governance boards or underlying systems. Instead they are focused on the outcome: will the banks be able to demonstrate they are running independent businesses that are in the consumer and the nation’s interest? Whether there are two layers of governance or twenty isn’t the concern of the PRA. Nor is there a requirement to run completely stove-piped organisations. As long as separate operations can be demonstrated then a bank passes the test.
In the water industry, where Ofwat has deliberately provided a high level definition of the level playing field, a similar approach could and should be followed. That means avoiding over-elaborate or ineffective governance structures and ensuring agility and ease of decision making.
Reports from the National Audit Office on failed programmes explicitly blame governance complexity for contributing to wasted spend. Excess governance adds cost in terms of managing dependencies and reduced flexibility of resources and prevents vital corrections being made. This underlines that water incumbents need to resist the temptation to add layer upon layer of complexity and focus on the outcomes rather than the delivery mechanism. If responsibility for delivering change is separated into a number of individual programmes, each of these requires individual governance as well as a further layer of processes to integrate decisions across each programme. This is clearly much more complex than having a single governance group and will introduce significant cost and lag in decision making that would severely jeopardise a 2017 market-opening deadline.
The uncertainty of the future market creates challenges for the IT needed to support it. Decisions need to be made about whether there will be a requirement to support an increase in pure customer numbers and how IT systems will have to scale up in a linear way to keep costs under control. Alternatively, they may need to target particular customer segments with a tailored experience and ensure they have the analytics capabilities to ensure the right in-area and out-of-area customers are targeted.
One of the biggest complaints around traditional software licensing comes from the high degree of uncertainty about lifetime cost and return on investment. This may explain the popularity of the “pay as you go approach” of Software as a Service (SaaS) and cloud-based computing in recent years as it allows organisations to scale up or down and move costs to OpEx. If things go well, you pay for more of the service through the revenues. If not, you don’t have a legacy system that eats through your IT budget for years to come. Global market intelligence firm IDC predicts that by 2017, and the time of the UK water retail market opening, SaaS will account for $1 of every $6 spent on software globally.
In financial services, the example of “challenger” banks which have seen a doubling in market share over the last three years, in parallel with the adoption of cloud-based computing, shows the potential impact. The OFT estimates that IT infrastructure accounts for two thirds of a start-up bank’s total costs. SaaS is credited with lowering this barrier to entry and facilitating the expansion of new entrants such as Metrobank. This has seen the number of its UK branches increase ten-fold in the last decade whilst its IT department still comprises only three people.
However water companies, traditionally characterised by a patchwork of legacy IT systems, are yet to fully embrace the opportunity presented by the market proliferation of cloud services specifically designed with utilities in mind. But there are some examples that show the potential of SaaS - Severn Trent Water recently cut their annual IT support costs by £1million by switching to a cloud based billing system.
However, UK water firms should remain pragmatic about the use of these new technologies and service models, since they still have key challenges to address in legacy IT. Investment needs to be made in existing IT systems and a balance must be struck to ensure core compliance in current wholesale systems. Equally, experience has shown that it can be difficult and time consuming to implement cloud based solutions across an established IT environment. All this means that providing effective and regulatory compliant integration of in-situ systems and the cloud is a challenge that requires well thought out investment but the problems it presents are not insurmountable.
Data: comply, compete or both?
By participating in the competitive market, organisations will need to share data with both the market operator and with one another and they need to make sure that the data is in the right form to be shared.
This is vital because accurate revenue is dependent on accurate data. Incumbent water companies will hold a large set of the data they need already, but they could be lulled into a false sense of security by thinking that, because they hold it today, it is fit for purpose. In the future market, data will be shared and used for different purposes - and the quality of that data has implications for compliance with the level playing field if inaccurate data prohibits effective market operations.
Organisations face a decision about their approach to data: do they use it to focus on complying or competing - or even both? In order to comply, the priority should be on the quality of data shared with other parties. That means understanding where the risk lies. For example, as part of recent changes to the classification of government documents a large government department focussed their efforts on making changes and ensuring compliance on documents that they share with external parties. This was the biggest risk to their activities, so the lower risk reclassification of internal documents was tackled in a subsequent phase.
In order to compete, the focus needs to be on ensuring the value of the data as, in a competitive world, information and knowledge is the driver of greater market share, securing new customer segments and higher margins. In the new water market a key area to consider is the identification of “gap sites”. In Scotland, they identified more than 10,000 gap sites over 18 months and new service providers were created to meet the needs of those customers.
The challenge for incumbents is that new entrants to the market don’t have to deal with legacy data and can focus on using their data to compete by understanding more about their customers and growing their market share. A good example of this is Amazon who use their Amazon Web Services capability to gain insight into their customers’ behaviour. They have also created common standards for interoperability between their internal systems so they will be able to combine them in the future to address new markets or customer needs.
In the water sector vertical integration was a historical key driver, sometimes delivered through technology but often through co-locating teams and joining up business processes. In the new level-playing field world this cannot exist and organisations operating within both retail and wholesale will need to put appropriate interfaces in place. For them, compliance will be a key focus but the attraction of competing and gaining market share will remain highly compelling too, and cannot be ignored.
Competition needn't stifle collaboration
Industry participants should recognise that every company in the industry is facing similar challenges. It is all too easy to use competition as an excuse for each water company finding their own way to solve the same problems. Yet that may not be the most efficient or effective approach.
Sharing information and collaborating across industries is at the core of the business plan of the Open Data Institute, (chaired by Sir Tim Berners-Lee and Professor Nigel Shadbolt). This has government backing and is gaining momentum by demonstrating how, if data is shared openly rather than hoarded internally, both organisations and the economy as a whole benefits. The Institute also acts as a stimulus for innovation, for example, using shared data to improve the energy efficiency of over 20,000 commercial buildings in the UK.
This underlines that there are real benefits to be gained from water companies being proactive and not waiting for everything to be defined at the centre. Ofwat and MOSL won’t consider the lead times and dependencies for delivery within the regulated firms. So there is an opportunity to work with fellow industry participants to develop the standards and offer those back to the regulator. This gives the industry more control over what the standards are, and assurance that, when they are available, they will fit the collective systems footprint and provide greater certainty to all.
Certain components of the new water market are prime candidates for collaboration, for example the definition of a common standard for the operational interfaces that will support data exchange between industry participants.
The example of the Energy Performance of Buildings Directive shows what can be done. Representatives from across a set of home building and energy efficiency organisations worked together to develop a standard for data interchange. This was subsequently adopted by central government as the mandated standard for submitting data to the central register of Energy Performance Certificates. This created standards that were more acceptable to the industry, cheaper to implement and industry had greater certainty about the technology and processes that they needed to support. A similar approach in the gas sector saw all participants in the SOMSA programme, which separated out the gas control systems, coming together to establish ways of working to meet challenging timescales.
The experience is out there to make rapid, informed decisions and get started
Whilst the changes in the water sector are unprecedented, there are many lessons that can be taken from other industries on what worked and what didn’t. These show that a rapid but pragmatic and informed decision-making approach is critical, underpinned by embracing technology trends, such as software as a service.
So while uncertainty is a reality, water companies have to face up to the fact that it doesn’t have to be an obstacle to a successful outcome in the competitive water market of 2017.
Greg Beard is a utilities expert at PA Consulting Group and Samantha Walsh is a programme management expert at PA Consulting Group