By definition, the extension of competition in the water market is disruptive innovation. It is designed to force change and transformation through new market forces, placing greater pressure on incumbent suppliers from customers and new entrants, thus creating a more innovative, competitive industry.
Incumbents are currently in the throes of planning for the next price review in 2014 (PR14). They need to factor in to their planning how they intend to respond to the new competitive pressures first mooted in the Water White Paper and now making their way, slowly, into legislation (see box). In particular, they need to estimate how much any necessary organisational transformation will cost and include it in their PR14 submission; whether they will be a pioneer or take a more cautious approach; and how much risk should be factored in.
Companies will not be forced to legally split into retail and wholesale entities. Nonetheless, separating retail and wholesale business functions is the best and safest way forward.
Under competition law, the wholesaler is obliged to treat all retail businesses as equal, including its own retail arm. It cannot give its retail business preferential treatment which could give it a competitive advantage, such as preferential price discrimination, sharing of scale economies, sharing information from other retailers or offering services at less than the market rate. By remaining as a single entity, an organisation leaves itself open to accusations of anti-competitive behaviour – a charge that carries a maximum penalty of up to 10 per cent of annual turnover.
The industry should take heed from the Scottish experience. Scottish Water separated its business retail activities into a wholly-owned subsidiary, Business Stream. This serves non-household customers and competes with other water retailers. Scottish Water, the wholesaler, deals with all licensed retailers in the market in a consistent manner. Scottish Water stresses the importance of adequate governance between these two entities to allow fair access to new entrants.
The alternative to separation is rigid compliance to Chinese walls within a single legal entity – possible, but complex and difficult to manage, and therefore open to accusations of anti-competitive behaviour.
Another argument for some form of separation is that wholesale and retail are likely to require different types of people, skills and leadership styles, not to mention processes and technologies. Such different operating models may make uncomfortable bedfellows.
The key message is to start planning now to ensure a safe passage into the next asset management plan (AMP6) and a steady future beyond. Though not required, business separation might prove the best – and safest – way forward.
Simon Talbot is an associate director and Sherna Bhadresa a consultant at Egremont Group
Key competitive pressures coming in
Business retail: the future Water Bill will open up the market to all non-household customers. This has huge implications in terms of the complexity of supply, service offers and increased pressure for value-added services. Core commercial skills will be required that may not be immediately available or apparent within incumbents.
Increased licence options : The Water Bill will unbundle the current combined licence and introduce a number of licences, providing opportunities for new entrants to specialise – for instance, providing upstream services, without being obliged to provide the retail services as well. Incumbents will need to understand the threats and opportunities presented by the new licence arrangements and prepare accordingly, assessing the skills, systems and processes required, as well as promoting a corporate culture throughout the organisation, compliant with a competitive regime.
Bulk water trading: regulatory incentives will be introduced by Ofwat, to make water trading more attractive and a model contract for bulk supplies will be developed. This will amount to more than just a means of moving water from those with a surplus to those with a shortage – it will be important when evaluating capital schemes. This will require a more commercial approach to understanding cost and profit opportunities to deliver the right long-term investment choices in AMP6.
This article first appeared in Utility Week’s print edition of 9th November 2012.
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