This article first appeared in The Water Report
With all of the discussion in the press of the water sector in England and Wales, and with just a month to go before Ofwat publishes its final methodology for PR19, it seems appropriate to step back and look at some of the wider implications for water companies of both the proposals set out in the consultation and the recent narrative from Ofwat.
Much has been said about the possible financial implications of a lower cost of capital in PR19, particularly by companies themselves. However, Ofwat’s agenda for PR19 is clearly more ambitious in terms of the culture change it is seeking. As well as the stated focus on innovation, resilience and a step change in customer service, Ofwat has made it clear over recent weeks that it is looking for water companies to demonstrate their legitimacy and credibility with customers and the wider public. Companies would be wise not underestimate the seriousness of the challenges the regulator has laid down and its intent to deliver on behalf of customers. As success in AMP7 and beyond rests on their ability to respond to these challenges, they need to consider whether they have a suitable overall strategy, as well as an operating model to deliver that strategy.
It is easy to say that strategy is less important in a highly-regulated industry such as water. Companies know what they will be doing today, tomorrow and for the foreseeable future: delivering water and sewerage services to customers within their licensed area. However, that would be to miss the point of what a strategy delivers. At its best a company’s strategy will be the golden thread that runs through the business providing guidance and meaning to all employees as they undertake work that may (to them) seem quite removed from the company’s core purpose. Effective strategies are also allow flexible and anticipatory. They allow a company to predict, adapt and respond to change quickly. Similarly, the lack of a coherent and comprehensive strategy is likely to lead to employees working in silos, duplication, inefficiency and underperformance.
That brings us neatly to PR19. It is clear that, beyond the stated themes, PR19 will bring more regulatory prescription (including the introduction of 14 common performance commitments). That includes increased levels of scrutiny on assurance and corporate governance, a focus on the long term (a minimum 10 year time horizon is required for most measures) and rewards for AMP7 being linked more directly to performance in AMP6. Ofwat has also sent out strong signals that the ODI regime will penalise companies in AMP7 if they continue with an average AMP6 level of performance.
It is difficult to see how, given all of these changes, water companies can continue to operate as they have been doing. To be successful in the future, companies will have to change and adapt, updating their strategy and using it to articulate and support how they will achieve these changes. However, a company as sophisticated and integrated within a community as a water (or sewerage) services provider cannot just decide to operate differently from a standing start. As the provider of essential services to the public, water companies must ensure that they have a strategy that enables any transformation and improvement process to be carried out at the same time as ensuring continuity of service and maintaining levels of performance.
This should start by identifying the end point, the vision for the company and what goals and targets it is trying to meet as part of that vision. Some of these goals and targets are being set by regulators such as Ofwat, the DWI and the EA, but many will also be set by customers through the PR19 customer engagement process i.e. the outcomes customers say they value and their willingness to pay for those outcomes. However, the majority must be set by the company itself through its management, employees and investors. Even though Ofwat has set out high level aspirations for the sector, for example more resilience, what that means for each water company will be different given their starting positions and unique circumstances. Similarly, for employees, customers and stakeholders to buy into the company’s vision it must be shaped and defined by the company itself rather than, say, its regulator.
Next, companies must map out all of the projects they have in-flight or intend to implement, alongside an assessment of the contribution each of those projects will make to the company’s vision. Most important this should include all their innovation and transformational initiatives.
In particular, this should ensure that the insights gained from the increasing use of big data and analytics are incorporated into a company’s day to day operations, securing their value and preventing such activities from being an expensive white elephant. Similarly, one of the most important findings of PA’s recent cross-sector research on innovation is that embedding innovation within any organisation is difficult and takes time and leadership. Water companies cannot just rely on good ideas or being enthusiastic about innovation to deliver any meaningful change in the way they operate, or lead to different and more positive outcomes for the company or its customers. They need a clear plan to use innovation to support specific changes to what they do.
This assessment of the contribution of each project should then be used to help the company choose its priorities. Being clear on its priorities will be vital for each company given the way that Ofwat plans to structure the incentive framework in PR19. With companies being asked to reach operational targets on some of the common performance commitments from day one of AMP7, they cannot afford for their management and employees to be working hard on delivering projects that are disconnected or tangential to the company’s actual goals and targets.
On its own a coherent and comprehensive strategy will not ensure that a water company will be classed as exceptional or fast-tracked through the PR19 business planning process. Nor will it guarantee that it will achieve its vision for AMP7 or the outcomes that customers want. However, what can be guaranteed is that without a coherent and comprehensive strategy that both informs and guides company management and employees, a water company will have very little chance of being successful in PR19. That is not a prospect that anyone connected to a water company – regulator, management, employees, investors or customers – should be prepared to accept.
Richard Khaldi is a water sector expert at PA Consulting Group