April 2020 saw the start of the new AMP period and it would be an understatement to say that it was not what we had expected or planned for. Arguably the most challenging regulatory settlement in the history of the industry came accompanied by a global pandemic, huge economic uncertainty, significant changes in population behaviour, our departure from the EU and a series of extreme weather events.
How has the industry coped with this maelstrom and what lessons can be learnt from this period? We assessed companies’ performance against performance commitments and interviewed people from across the industry and supply chain to understand how year one of the AMP has gone, to consider the lessons and to assess how the industry can position itself for the continued AMP7 challenge.
PCs – a tough start
PR19 introduced more onerous performance commitments with steeper penalties. This was accompanied by a £6 billion efficiency challenge and additional requirements on improving resilience, protecting the environment and customer service and still reducing bills.
The first year’s outcomes, perhaps unsurprisingly, do not make good reading. As the table below shows, a significant number of companies did not achieve their common performance commitments and this will result in significant penalties across the industry.
Most notably, all failed to meet their PCC reduction commitment, which would seem an exceptional outcome. Scores on water quality compliance and mains repairs are also weak. Sewer flooding, pollution incidents and supply interruptions all proved very challenging with over half of all companies missing these targets. Leakage, which has been a key focus of the industry over the last few years, actually provided better outcomes than these commitments - although nearly a third of companies still missed their targets.
In interviews, companies also reported patchy progress on resilience and the missed mains repair targets are evidence of this.
Determination or exceptionals?
The key question is the extent to which these results are because the settlement was too onerous, as some companies argued in their CMA submissions, whether companies were not able to rise to the challenge, or due primarily to a set of truly exceptional circumstances which are now abating. This assessment must inform how the industry reacts to place itself on course for the rest of the AMP.
On PCC and sewer flooding, companies report evidence of the impact of the pandemic. Some of the increase in demand can be attributed to the hot summer that was experienced across the UK, but these outcomes also illustrate the scale of shift in demand patterns as a result of increased home working. With this water demand and the creation of sewage happening significantly more in some locations such as villages and commuter corridors rather than larger towns and cities, this has caused issues across the wider network such as low pressure, flooding (overwhelmed pumping stations) and pollution incidents caused by smaller sewage treatment works being overwhelmed by increased flows. The challenge of understanding the new normal is still being felt across the industry and companies must continue to find more precise ways of measuring these changes and the second order effects of change in demand to both adjust their plans and have conversations with Ofwat.
Mains repair targets have also been hit by the pandemic and extreme events. COVID-19 created the need for new working approaches and impacted the availability of the workforce generally. Extreme weather events such as storm Ciara (delivering one month’s rainfall in 18 hours) and an increase in bursts have also diverted the workforce to tackle immediate issues rather than long term improvements.
In interviews, several companies argued that the flat bills agenda, when coupled with the expansive enhancement challenges they are dealing with, is placing significant stress on areas such as mains replacement. One director stated: “Absolutely and undeniably Ofwat’s cost challenge has driven a short-term resilience approach…we are, rightly or wrongly being forced to take short-term measures at the expense of long-term resilience”. Brexit is also reported as having some limited impact on workforce availability, the supply chain and pricing.
Over 30% of companies have struggled and in some cases failed to achieve their year one leakage targets. This appears be partly due to the pandemic and an increase in demand (or more pertinently there has been a need to improve data quality to understand demand in the round) and partly due to the challenge faced by companies already in the upper quartile trying to achieve similar reductions to those further away from the frontier. Perhaps unsurprisingly, the average reductions achieved by the companies closest to the frontier are less than those with historically higher levels of leakage. This potentially questions whether the 15% flat reduction at PR19 was realistic for companies already well beyond their relative SELL.
In inteviews, several companies did also accept that, even without the exceptional circumstances, they needed to have been sharper in their preparations for AMP7. In particular, there is concern that companies’ operating models are not set up to cope with the degree of challenge, with a need for greater alignment between Finance, Asset Management, Digital and Operations functions. Leading companies are looking at how businesses can be redefined to create ‘one team’ focused on a single, or related group, of ODIs.
While the pandemic has had a harrowing personal and economic impact, it has also brought some positives across the industry - in particular an even greater sense of purpose for customer service, and cross industry collaboration.
Relationships between customers and companies have strengthened across the sector. CMeX and DMeX have both also increased since 2019/20 despite the challenges to delivery during the pandemic. However, with many customers remaining working from home, companies will need to embed the temporary practises they may have developed to deal with this in the pandemic. This will require companies to continue to accelerate their digital presence, enabling smoother customer experiences fed by ever more real time information, this will bring companies in line with other service industries and therefore customer expectations.
Several companies also report that the pandemic has significantly improved collaboration between themselves and the supply chain. The ‘one nation in it together’ attitude has filtered through to the industry workplace to professional relationships to promote collective focus in achieving goals. To successfully recover from the pandemic and continue delivering on the remainder of their AMP7 regulatory contract (particularly with compressed timescales), companies will need to make this culture of togetherness last, building and embedding innovative hybrid collaborative working models and reviewing contractual arrangements and incentives to support this.
Another positive impact has been the demonstration that technology can really transform businesses. The industry, like many, has a chequered history in delivering large scale IT programmes that are meant to transform the business but often run over time and budget with questionable results. But the pandemic has indisputably shown the transformative nature of IT. It has enabled us to move a substantial amount of the company’s functions to an entirely new operating model of working from home – for many in a matter of days or weeks – and this model has sustained for over 18 months.
There is also considerable evidence that companies have recognised the scale of the AMP7 challenge and, despite the distraction of the pandemic, have been putting substantial investment behind transformation to position themselves for the next four years. We are seeing significant efforts in digitisation of customer experience and asset operations in particular.
We are now in a critical year for the AMP as investments need to be made now to deliver results within this period. Looking back at year one, we believe there are positives that can be carried forward to help drive performance.
Firstly, there is evolution in many companies’ operating modes, workforce of the future plans, and approaches to productivity. The pandemic has shown that rapid change can be successful and heightened the need for clear alignment between functions. It has created greater collaboration and a more positive culture, in particular between the industry and its supply chain. This is a significant opportunity that must be sustained and built upon.
Secondly, there is a need to embrace the opportunities of digital. The pandemic has illustrated the power of technology and the challenges of AMP7 will not be overcome without greater automation, more timely and accurate information and a clear line of sight from the top-level performance commitments to the teams on the ground delivering them.
Lastly, the industry needs to focus on resilience. Several companies report that the pandemic, the need to try and hit year one targets and the constraints of the regulatory settlement have limited longer term planning and action on resilience. The extreme weather events of the past year have illustrated the need for resilience in our infrastructure is becoming more urgent. It has also illustrated the broader need for resilience in the supply chain. Talent resilience is a case in point. Redundancies and the vast uptake of furlough schemes clearly demonstrate the cash flow fragility of the supply chain and companies must plan for this going forwards. A recent British Water study concluded that just under 60% of supply chain companies interviewed reduced or furloughed staff to secure their cash flow position. Coupling this fragility with the backdrop of an industry skills shortage - in part due to other large national infrastructure programmes - reiterates the need for companies to build their own resilient workforces.
Year one has seen many of the companies fail their common performance commitments and incur significant penalties. It is important to understand the root cause of this and how that might influence future regulation, particular in areas where 100% of companies fail a commitment, which suggests that commitment is simply too challenging. However, companies must also seize the opportunity of the gradual evolution of the new normal to take the positives from year one and drive change across their businesses to position for the rest of the AMP and PR24.
In order to meet commitment targets for the remainder of the AMP, companies must accelerate programmes of work delayed by COVID-19 in order to minimise the risk of commitment failures across the rest of the AMP. A number of companies described the start to this AMP as slower than most which may be reflected in the failure to meet some of the common commitments in year one. Companies must therefore work efficiently and identify programmes of work that target multiple performance commitments. Developing and implementing robust business, customer and asset strategies and thereby minimising siloed programmes of work has never been more important. Companies should develop comprehensive network strategies to ensure that all interventions are considered against a range of ODI benefits and ensure companies deliver the best balance of ODI performance and totex over AMP7 and put them in a good starting position for AMP8.