In the dynamic landscape of GB water networks, MCC Economics & Finance navigates the challenges of PR19, spotlighting the 4 key factors for success.
As GB water networks gear up for the challenging PR19 review, MCC Economics & Finance takes the lead in outlining indispensable factors. From navigating cost benchmarking intricacies to fostering transparent communication, this publication serves as a compass for water companies aiming to deliver meticulous business plans. Explore the comprehensive strategies designed to ensure sustainability, integration, and effective storytelling in an evolving regulatory landscape.
1. In July 2017, Ofwat published a consultation regarding its methodology for the next price review, PR191 . The water networks of Great Britain now face a major challenge to produce quality business plans for the period 2020–2025. Ofwat will classify each plan into one of four categories based on its view of the plan’s quality2 . The incentive for submitting a high-quality plan may be larger under PR19 than it was under PR143.
2. MCC Economics & Finance outlines below 4 key factors for this part of the PR19 review.
3. The age-old strategy of exaggerating costs (maintenance, enhancement or finance)and risks is well known (and popular) through the c30 years of economic regulation inwater and other sectors. However, in the water sector, any exaggeration comes at arisk of being found-out, either through benchmarking or simple comparisons withother companies. Competition from c17 other companies means it is relatively easy tospot material exaggeration. Therefore, great care needs taken if any such strategy isemployed.
4. In fact, the incentive from Ofwat for PR19 now means that companies are incentivised to forecast low, even if a low forecast is inaccurate, inefficient, or inappropriate, while simultaneously influencing Ofwat’s benchmark baseline upwards.
5. Historically, we can see the scale of over-or-under bidding, relative to Ofwat cost forecasts, by looking at the previous review by Ofwat, the “risk-based” assessment. We find that the most significant factor for Ofwat’s PR14 evaluation of business plan quality is the cost benchmarking test.
1See Ofwat, “Delivering Water 2020: Consulting on our PR19 draft methodology”, July 2017.
2bid, page 14.
3During the early stages of PR14, Ofwat estimated that South West Water benefited by around £17m and Affinity benefited by around £7m, as set out in “PR14 price review document”, page 10. The PR19 incentive, given upside of 0.2% of RORE, seems to be more about downside risk than upside risk for the companies.
4See Appendix 1 below.
6. now proposes a mechanical relationship between company bids and its baseline view of costs, such that ex-ante cost benchmarking determines ex-post cost-risk sharing rates.
7. Therefore, if we assume that the cost-efficiency test is a prerequisite to a favourable cat egorisation from Ofwat, and given that this view drives cost-risk, it could perhaps also be assumed that Ofwat’s cost-efficiency test is more important than its view of ambition or innovation, and that cost benchmarking will be more important for PR19 than it was at PR14, given the long-term financial implications.
8. Thankfully, Ofwat published its initial benchmarking models for PR14, albeit in read-only format. One might reasonably expect that the PR19 benchmarking will yield similar results, although Ofwat does say it is developing new models for PR19.
9. Getting the right information to the right parties at the right time will be crucial for asuccessful PR19 business plan. Many business plans from regulated monopoliessuffer from repetition, lack of transparency, and lack of depth. In PR19, watercompanies face challenges to: set-out initial plans, consult early, gather feedback,distill & weigh options, and modify & re-consult. Stakeholders such as: the DrinkingWater Inspectorate, Consumer Council for Water, the Environment Agency, and theConsumer Groups, can all help develop a quality plan. The challenge is one of timing,scale, planning and tailoring.
10. Each stakeholder group will have different expectations. Optimal communication witheach stakeholder (ie method, style, depth and agenda), will allow a quality plan toemerge and be evidenced. Combining the overall communication strategy will allow each water network to demonstrate the process that has been undertaken, how thebusiness plan reflects it, and how it maps to the final business plan documents.However, unnecessary or ‘token’ communication with stakeholders is in-itself a riskto credibility, resources and on-time business plan delivery.
5. See Appendix 1 below for PR14 (initial) benchmarking results: the cost benchmarking was the most significant test fordetermining which plans were deemed high quality (or, as it was known, ‘enhanced’).
6. See Ofwat July 2017 consultation, page 168.
7. We presume that Ofwat actually want the companies themselves, as opposed to just their published plans, to be ambitiousand innovative. We also presume that Ofwat will try to guard against company business plans being driven by regulatorymodels of cost assessment (see Ofwat July 2017 consultation, page 175), although there is no indication of how Ofwat woulddo this.
8. Ofwat, “Initial PR14 cost benchmarking models”.
11. A quality plan will have many overlapping and cross cutting integration challenges. Within each water company inter-departmental views need combined although perhaps not (in the early stages) ‘resolved’. The water industry supply chain can help provide solutions and help manage or avoid risk. Stakeholders will undoubtedly have different views – these could be anticipated and challenged in order to find win:win situations. Overall, these types of integration are in-and-of-themselves, important stories to relay to Ofwat to help explain the tension and trade-offs which underlay the overall plan. The challenge is to ensure that there is an overall programme and strategy to integrate the many contributors.
12. However, each water company will need a select number of individuals to lead and decide on the appropriate balance and prioritization of the integration issues, while considering the inevitable and imminent challenge and scrutiny from Ofwat (and others). An early draft plan and an early communication roll-out will help practice and prepare the integrating features of the plan.
13. Economy and value should be the overriding factors throughout. Consulting early, often and widely, seems to be best strategy to ensure integration can be obtained and evidenced.
14. A great plan will be underpinned by a great story. The factors outlined above willeach provide opportunities to document: changes, challenges, issues, ideas, risks, fearsand uncertainty. A good process will systematically gather and document issues sothat the water company can sell its story.
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