The draft determinations published by Ofwat in July have caused an audible stir in the sector. A brief review of water companies’ responses reveals a number of common themes, including adverse consequences for customer expectations and an unattainable benchmark, not to mention concerns about financeability.
One particular concern is Ofwat’s very firm line on costs, with many companies facing significant challenges for the next AMP. At the same time, it is maintaining pressure on the sector to significantly improve performance in key areas such as leakage and sewer flooding reduction. Performance improvement has been a consistent feature of Ofwat’s approach to PR19 and it has been clear for some time that it will not be possible for the industry to address these challenges in the same way as it has done historically.
The industry has already recognised the need to do things differently and has been taking action to seek more innovative solutions to these problems. Hackathons, innovation festivals/hubs/labs, etc. have been actively progressed. Indeed, it is clear that the level of performance improvement that Ofwat is demanding requires disruptive innovation on an unprecedented scale but there are fundamental barriers to making that happen.
True disruptive innovation requires a culture of risk-taking and lesson-learning; procurement that is able to access new ideas and progress them; a financial model that recognises that some innovation will fail and a willingness to embrace change and absorb it into the business. However, at its heart, the water industry operates in a way that is the complete opposite of these principles. Risk is seen as something to be avoided in case it endangers the primary mission; procurement is there to drive towards the lowest cost, lowest risk; financial models are based on long-term, steady return; and disruptive change is seen as too much of a distraction from the day-to-day challenges, which are already significant.
Innovation and collaboration
The price review also sets out an explicit expectation for companies to tackle their common problems by working more closely, not just with their supply chain, but with each other, and their customers and to engage with, other sectors. This drive for collaboration was further highlighted in Ofwat’s recent publication – Driving transformational innovation in the sector.
In driving innovation this makes lots of sense, each company has similar challenges, and a shared approach to tackle those challenges by deploying new technologies, new processes, new capabilities is a proven and effective way of sharing the cost and risk. However, this is in tension with the ‘upper quartile’ approach because in a competitive world, disruptive innovation is an opportunity for competitive advantage and is to be jealously protected – not shared. That leaves the industry with two obstacles in the way of performance improvements: the need to get innovation started in the first place and the need to make it collaborative.
It will need to overcome these obstacles if it is to meet the expectation from the regulator, general public and the media that water companies will achieve the goals set out in their business plans. There is a clear need to deliver tangible efficiencies, and demonstrate real savings to customers in their annual bills and the only way to do this will be to seize the initiative and make collaborative, disruptive innovation happen.
Ofwat needs to provide mechanisms to support and reward that initiatives to nudge the industry towards performance improvements rather than focus on an inward spiral towards self-promotion.
It is clear that more collaboration and innovation and empowering suppliers will allow the right products and services to be deployed faster and more cost effectively. For example, combining industry purchasing power could enable a streamlining of asset requirements, negotiate an industry unit cost with every company able to lower customer bills.
Ofwat can support this through mechanisms that encourage the sharing of best practice, support for collaborative innovation projects, derogations for water companies trying some new technologies (with the right assurance of course). It should also support change programmes that scale up those innovations and a central, co-ordinating portfolio of innovation that can be communicated and shared across the industry.
There are examples of how this can work in other industries such as the CAA Innovation Hub or co-projects delivered through the Ellen Macarthur Foundation.
AMP7 provides an ideal platform to deliver value and help address the cost challenge by adopting collaborative arrangements. A focus on joint value creation in AMP7 gives all parties the opportunity to combine innovation and expertise and achieve increased efficiency and savings for customers. Some are already aspiring towards this approach, but it is too soon to tell how far these collaborative relationships will be taken. Success will depend on getting the right principles in place to nurture them and critically needs support from leaders who truly see the benefits and are prepared to drive the changes in behaviour that will make true collaboration and innovation a reality.