Opinion: One year to market opening

It is now one year until all businesses, charities and public sector organisations in England will be able to choose who supplies their water and sewerage service. The opening of the retail market represents the largest single change in the water sector since its privatisation in 1989.

There has been considerable attention paid to several important issues surrounding market opening:

– the accuracy and completeness of data
– the central registration and settlement system and the establishment of a market operator
– the gross retail margin and the allowed for net profit margin
– how readiness should be determined

These are all important issues – but perhaps the extent of debate on these issues has reduced discussion about some of the other factors that will be essential to an effective market that works well for customers. In my view there are ten important issues that are worthy of discussion. These ten issues can be conveniently sub-divided into four broad themes. Issues that relate to:

– the overall strategy of an incumbent water and sewerage or water Group 
– the finances of both Group and retail entities
– the strategy of an individual retailer
– some quite complex readiness, regulatory and market operational issues
 
Overall Strategy

Question 1: How do you plan to organise your non-household retail activity? We developed a heat map to illustrate the issues that need to be considered. Fortunately, incumbent suppliers in the industry do have the choice to exit. But if you choose not to exit, how will you ensure that there is a level playing field? And act in a manner consistent with the market code?

Source: WICS

Question 2: Assuming that you have decided to use the exit regulations, what is the opening balance sheet of your new retail entity going to look like? How much capital is being injected into it? And where is this capital going to come from? Of course, such decisions have to be taken in a manner that will not skew the level playing field if an incumbent company does not want to open itself up to challenge. In Scotland – particularly given the public ownership of Scottish Water- ensuring that there were not grounds for a challenge under competition law was particularly important.

Question 3: Can you evidence that your retail business takes decisions on their merits? And can you further evidence that your retail business does not have a position of privilege in your home area? How do you plan to do this? In Scotland there is a detailed published governance code that sets out how the wholesale and retail businesses may interact. For example, all commercial relationships between Scottish Water and Business Stream have to be published and signed off by WICS.

The finances of Group, Wholesale and Retail entities

Question 4: What legacy assets (billing and call centre systems, vans, IT equipment etc.) will an incumbent company include on the balance sheet of its retail business? If they are retained in the wholesale business how will the appropriate cost of using these assets be paid for by the retail business – recognising, of course, that these assets will need to be replaced at the end of their useful life.

Question 5: What is your expected rate of return for the retail business – not in terms of a net margin, but in terms of the capital employed in your retail business? And, in that regard, can you evidence that a profit can be made in serving each class of customer in your home area? Accusations of margin squeeze are avoidable – but only if you have thought carefully about what each class of customer costs to serve.

Retail Strategy

Question 6: Do you have a retail strategy? And what have you done to ensure that this strategy is consistent with wholesale tariffs in your home area? In other words, can you make an acceptable return on capital employed by pursuing your chosen strategy. And will wholesale tariffs in other areas of the country allow you to pursue this strategy?

Readiness, regulatory and market operational issues

Question 7: What plans are in place to respond to the inevitable errors in data that will be uncovered by switching and the activities of new entrants seeking business in your area?

Question 8: How much does your retail business expect to pay the Market Operator for its services? How much will it pay for each class of customer? And is this reflected in the tariffs that have been set? And what about payments to the regulator for its market supervision activities?

Question 9: How does the market operator/ regulator evidence how much its market administration fees should be and how it spends them? New entrants are likely to be very interested in such costs and the balance between incumbent and entrant, between wholesaler and retailer.

And households will want to be assured that none of the set up or operation costs of establishing these new market arrangements will have been added to their bill.

And finally Question 10: What would happen to a wholesaler if a large retailer were to fail? How would customers be protected? And, in particular, how would non-contestable customers be protected?

These are challenging questions that I would suggest market participants could usefully consider. It took us – in Scotland – a long time and lots of effort to address them – and we did not get all of them right. Fortunately, for me as the regulator, most of these questions fell to the wholesale and retail businesses of Scottish Water to address. But we, as regulator, still had to be alive to the consequences of how these issues were addressed – to do otherwise could have undermined the integrity of the new market arrangements. This would not have been in the interests of customers both non-household and household.

Ironically, a successful market opening requires all parties to work closely and collaboratively together – in order that they can compete fiercely and fairly later.