Stève Hervouet, Keith Gardner and Steve Frobisher | the water report | 20 may 2016
This article first appeared in The Water Report
The strategic landscape for the water sector is changing more significantly than at any time since privatisation in 1989. Yet the full implications of these changes are yet to be widely recognised. As a result, it may be tempting for some water companies to respond in a passive way and simply focus on ensuring they comply with the requirements set by Market Reform. However, the Severn Trent/United Utilities Retail joint-venture, announced at the beginning of March 2016, shows that a passive approach is not going to be a sustainable long term position.
There is an increasingly urgent need for water companies to develop coherent strategies to deal with competition. They must now choose where and how they want to play in the new environment. There are two clear options. They can take a reactive stance to competition in the retail market, complying with the minimum requirements arising from market opening but without taking any additional measures, essentially a wait and see approach. Alternatively they can take a proactive position deciding either to compete or not to participate in the competitive NHH market (i.e. to exit).
Reactive stance: “Wait and See”
The wait and see position gives companies the chance to see how NHH competition will develop and gives the market time to settle. It also allows the first movers to test the new framework, and let others see how things develop before making any significant move.
This may appear sensible, considering the difficulties inherent in any project of this size, the small short-term financial impact of Market Reform, and the lack of experience of water companies in managing open market competition. However, the reality is:
the market will settle and a company involved from day one will be better prepared to face any issues related to the competition process that emerge later on
the financial impact will significantly increase if/when the household market opens to competition, and there will be an even greater impact associated with upstream competition
the sooner in-house commercial experience is developed, the better prepared companies will be to compete within a less regulated and more competitive framework.
So while a wait and see approach is superficially attractive, this position carries more risks than taking a more proactive response.
Proactive stance to the challenge of retail non-household competition
A proactive stance to compete
A proactive decision to compete should start with a recognition that a strategy of defending a company’s existing customer base is unlikely to be a viable option as, over time, customers will be cherry-picked by other competitors. The fixed cost nature of the business means that there is no choice but to proactively target non-household customers outside an incumbent’s geographic area. This decision to compete for new customers will only be successful if a number of key business processes, such as customer service and tariff setting, are managed exceptionally well. In the case of customer service, this could be achieved through a more personal relationship with the customer.
Companies also need to decide which customers or customer groups will be both targeted and defended. This process has now been made easier by Ofwat’s creation of a transparent market through the publishing of extensive customer group and tariff data at PR14. As a result such decisions can now be based on detailed analysis, enabling a realistic assessment of the likely costs and benefits of acquiring key customers.
Water companies should look at the experience of others, such as the electricity or Scottish water markets, where similar changes have taken place in recent years and learn from retailers who have also had to deal with comparable situations. These retailers have now acquired the commercial expertise that could potentially give them an advantage in the English retail NHH market – and so could pose another threat to those water companies who decide to adopt a reactive stance.
Proactive stance to exit
Alternatively, if companies decide not to participate in the competitive NHH retail market then the detailed implications need to be considered rapidly. Even though non-household retail volumes are relatively small, the largely fixed cost nature of the business, and an inability to exit the household retail market, mean that coming out of the NHH retail market will increase the costs of serving the household market.
Compared to some of the other options, companies may feel this is a price worth paying, because it will enable them to focus on other aspects of the business without distraction. But they still need to understand that the decision to exit the market will have long-term implications on the overall business.
What is important is that they address this fundamental question sooner rather than later. That means ensuring that they conduct a thorough review of the commercial, operational, regulatory and financial implications for the business of exiting.
It is clear that Boards and Executive teams need make long term decisions now, recognising that their room for manoeuvre will become increasingly limited as we head towards April 2017. That means looking beyond ensuring the necessary regulatory compliance with Market Reform requirements to weighing the full range of options. This should be based on a thorough analysis of the business and an understanding of the dynamics of the market. A clear focus now will be the best way to ensure their long term success in an increasingly challenging market.
Stève Hervouet and Keith Gardner are water experts at PA Consulting Group. Steve Frobisher is business strategy expert at PA Consulting Group