Getting contractors onboard

For AMP6, Ofwat is adopting a regulatory model based on outcomes rather than outputs, but have water companies aligned their contractor model to this new world? By Terry Povall.

Following the submission of the water companies’ business plans in December 2013 Ofwat will carry out a risk-based review that will see elements of the plans assigned a category of enhanced, standard or resubmission. Ofwat will test the plans against: outcomes; costs; risk and reward; and affordability and financeability.
Key water company challenges for AMP6 (the sixth asset management plan period) will be to optimise the balance between the need to replace and modernise an ageing infrastructure with affordable and sustainable solutions, while meeting conflicting stakeholder expectations.
Following the final determinations next year, water companies will need to ensure that the operating models they have in place will deliver the required performance that aligns to the new regulatory environment.
New models are required as the regulatory process moves to an outcome rather than output-based focus and there is a stronger emphasis on customer satisfaction and willingness to pay. Previous models focusing on project and programme performance will not give the required level of regulatory and business performance.
In developing “outcome” based solutions, every decision will need to be challenged on an “outcome” basis. Guidelines for outcome-based incentives were published in September, and while water companies have been focusing on what their outcomes are and how they might deliver them, little of this is being communicated with the contracting partners who are used to more traditional output-focused contracts, even in alliances.
The infrastructure market is very buoyant and contractors are positioning themselves differently with lots of consolidation and strategic teaming as they look to compete for the long-term sustainable revenue that the water sector provides. But are the contractors businesses models fit for purpose for the new outcome-based approaches and do they know what is going to be expected of them?
In the past, a clear reflection of those expectations was how incentives were based; that is, mostly on financial performance on project and programme outputs with some links to key performance indicators on other areas such as Health and Safety Executive performance. Some companies went further with links to company business plans but these were all retrospective with no contractor input into the plan.
Balancing the future needs of water companies with contractors may ultimately be about how companies link their outcome measures and metrics into the contracts with the contractors, or whether they do that at all. One challenge here would be how to address those frameworks, which are simply being extended into AMP6. Those companies that have either already completed negotiations or are negotiating with new contractors and establishing or have established Early Contractor Involvement (ECI) with their contractors will have a distinct advantage.
It is still a bit of a guessing game as to what Ofwat is expecting. Risk-based regulation means that the companies will not know until April whether their plans are assessed as enhanced, standard or resubmission. Does that realistically give them enough time to establish appropriate measures and metrics for contractors? If the water company is seeking a partnership-based approach with contractors, will it be able to set the parameters for the contractors to allow them to meet the required outcomes in the optimal way?
We see a range of different models in operation and it is not right to say whether any one model is better than another because it is all primarily about the current needs and position of the client water company as to what will work best for them and their strategy.
The individual models are built around four key milestones which dictate the type of model and how and when it should be implemented. The four types can be further defined under two groups, ­pre-determination and post-determination. See box, above.
The pre-determination models mean that business plan risk is aligned with the supply chain, the ECI leads to early identification of efficiency and the long-term aspect should encourage innovation. On the downside they do have a high set-up cost and can close out market areas for long periods, so the appropriate flexibility needs building in.
The post-determination models mean that clients can benefit more from the efficiencies built into the plan without the need to share with the supply chain as long as they are realised. Set-up costs are lower but the short-term impact of the supply chain’s engagement does not encourage innovation.
A key question with all this is whether the alliance models, either current or new, can deliver something different. Will the supply chain essentially just fit their own business model into any framework – whether the client is looking for an alliance or a traditional transactional contractor relationship? How ready are the contractors for an outcome-based approach? Given the growth in opportunities on major UK infrastructure projects, do they need the aggravation of remodelling their operating model to fit the new requirements of an outcome-based approach?
To get the right model developed and implemented, a range of knowledge and experience across all types of models is needed for a client to determine the best approach given their current circumstances. The key influencers will always be the size of the programme, the work mix, financial stakeholder pressure and most importantly, lessons learnt from existing model success or otherwise.
Those companies that have understood the market appetite and aligned the programme and work mix to both the appetite and what is right for them and the future regulatory models are already on right journey.