Lessons must be learnt from late PR14 changes

As thoughts start to turn towards the next price review (PR19), the industry is calling on Ofwat to learn the lessons from a partially flawed PR14 process, whereby late changes left some of the companies far from happy.

Bristol Water’s discontent with the price review process is well known, with the water-only company rejecting its final determination in February, claiming flawed modelling by Ofwat “disproportionately” hit the company’s planned expenditure and proposed revenue. The Competition and Markets Authority (CMA) is currently investigating the final determination and is due to publish its determination in September.

But Welsh Water and Northumbrian Water have also voiced their criticisms of the PR14 process, focussing on the late inclusion of key performance indicators for the whole industry, and the problems that caused. Ofwat itself is in the middle of a review of the price review process, where it will assess the price review’s shortcomings and find solutions so it can improve the process next time around.

The issue Welsh Water and Northumbrian Water have with the process stems from the “horizontal incentives” added into the price review process at a relatively late stage. They claim this goes against the ethos that customers and water companies should own the business plans and set out their own priority areas.

These incentives are designed to measure the key outcomes of: interruptions to supply; water quality contacts; drinking water quality compliance; and leakage; as well as internal sewer flooding; and pollution incidents for water and sewerage companies.

In a submission to the CMA’s inquiry into Bristol Water’s final determination, Welsh Water praises the regulator’s “innovative approach” of allowing on the companies to create their business plans and but warns this good work risks being undermined by having these areas of measurement.

Welsh Water stated they may result in the company having to “divert resources to the achievement of targets that do not appear to be the highest priorities for our customers, and which were not part of our plans, and away from other priorities that were”.

In the submission, Welsh Water director of strategy and regulation Mike Davis said: “A unilateral change to these performance targets at a late stage in the process without time or process for proper consideration and little or no recognition of the cost or price consequences, or even out customers’ preferences, means that the outcome was more crude and unsatisfactory than it had to be.”

The company said the price review sets out “a number of challenging measures”, but added in a statement that “in the round, the business plan strikes the right balance that will enable us to bring significant benefits to our customers, their communities and the environment – both now and in the future.”

Northumbrian Water chief executive Heidi Mottram said Ofwat had to take action to ensure the companies’ performances could be compared because each plan was structured and composed in a “slightly and subtly different way”.

She told Utility Week this was an “inevitable consequence” of the approach to the price review taken by the regulator, and that something had to be done because “we were coming up with a situation where some companies could be earning a financial incentive for delivering a level of performance that other companies would be being penalised.”

Mottram said the solution to this would be for the companies, and their customer challenge groups (CCGs) to have data from the other companies, so a comparison could be drawn when the plans are created, and customer priorities still being the focus.

Not having this data available meant some customer representatives were unable to work out if they were getting value for money, therefore Mottram said she “absolutely backs” the inclusion of the performance targets, even though they were added late on in the process.

She also said that to avoid a repeat of this situation the regulator must set out early in the PR19 process “some kind of minimum standards” to allow comparisons to be drawn between the water companies.

The “lessons learned” review currently being conducted by Ofwat is examining this issue, and discussing whether standardised targets should be set unilaterally across the sector, or whether bespoke targets should be drawn up. The outcome of this “big debate” – which is still to be had – will feed into Ofwat’s Water 2020 programme, which will in turn help shape the future water sector and PR19.

Another element being carefully considered by the regulator is how more information can be given to the customer challenge groups – in whatever form they take as the PR19 process gets underway – to allow the comparisons between the companies to take place.

This will “empower the customers” further to challenge the business plans that are put forward, and to ensure they are getting good value for money.

The ghost of PR14 has once again risen its head – before it has finally been laid to rest – but its haunting of Ofwat and the sector will help the regulator to set out a programme that ensures customers’ needs are met and the performance of the companies can be benchmarked against each other. And one without any last minute changes.