Utility Week expert view: Karma Ockenden

“The difficult bit for companies will be deciding how far to go in each of Open Water’s areas, given there is no legal separation requirement.”

I’m one of those people who needs a deadline to galvanise me into action. Maybe the same is true of some of the water companies: they’ve known retail competition in 2017 was a real prospect for some time now but as yet they’ve opted out, possibly for good ­reason, of making hard decisions on how to respond.

Well, make no mistake, we’ve just entered the 11th hour. While there is an obvious decision to make – to business retail or not to business retail – the more pressing question in the short term concerns how companies should structure themselves in readiness for the competitive market.

Two crucial elements are in play. First, the new price controls starting in April 2015. For the first time, Ofwat is effectively treating companies as comprising four self-contained business units: water wholesale, wastewater wholesale, household retail, and non-household retail. Consequently, they will no longer be able to switch resources from one part of the business to another so must be ready to live within discrete price controls.

Second, Open Water’s competitive market architecture plan was published last week. Not only does this develop and tweak the market blueprint published in January, but it plugs some of the gaps in the earlier document – most notably, on how to ensure a level playing field for all retailers. This demands swift and decisive action from incumbents to both ensure – and to be seen to ensure – that new entrants and out of area retailers get a fair crack of the whip.

Incumbent retailers potentially have access to all sorts of information that other retailers don’t – for example, unit prices for services provided, operational information and customer service history. An arm’s length relationship between incumbent wholesaler and incumbent retailer will be necessary. And companies will have to demonstrate this via tests such as non-preferential treatment of the incumbent retailer, appropriate governance structures and cost-reflective service provision.

This will require practical changes including the establishment of a wholesale business to serve retailers; company governance changes; redefining staff roles; IT system changes; and changes to cost allocation rules and processes. It will also require cultural change – in particular, the creation of a faster-paced, customer-responsive retail business culture for any customer-facing operation.

So far, so clear. The difficult bit for companies will be deciding how far to go in each of these areas given there is no legal separation requirement; how deeply to split their retail from their wholesale operation. The Open Water market plan provides a neat summary of the options available and acknowledges there are trade-offs: an arrangement close to legal separation would be far safer in compliance terms (remember competition law) but costly in upfront set-up costs; minimal separation would in contrast be low cost now but riskier and potentially expensive to maintain given regulatory requirements would be heavier for shallow-separated companies. There are, of course, a range of options between these two extremes.

Clearly, these are a company’s decisions to take. However, Ofwat will be looking for company boards to provide assurance of compliance; separate boards and compliance officers have been mentioned, though the precise level of assurance sought would depend on the depth of separation adopted. For sure, the regulator won’t shy away from intervening if it isn’t satisfied customer interests are being protected.

Ofwat’s chief regulation officer, Sonia Brown, confirms what we would expect: that different companies are taking different approaches. Some have already fully separated their wholesale/retail operations; others are in the process of doing so. But there are plenty who haven’t yet nailed their colours to the mast, and others who are reconsidering their line of thinking now that retail exit is an option. Brown says she expects all companies to have made a strategic choice within six months.

Level playing field aside, there is a second requirement that the Open Water plan flags up: setting an appropriate gross retail margin for each service type and class of customer. Too high a margin could lead to cherry-picking of customers; too low a margin could lead to accusations of margin squeeze. However, this is far from a straightforward task. It requires an understanding of both costs to serve, including issues such as bad debt, frequency of billing, and the likelihood of call centre contact, and the underlying costs of wholesale supply by class of customer and service provided.

Launching the plan last Thursday [3 July], Open Water programme director John Parsonage’s mantra was that companies had an awful lot to do. He’s not wrong, and time is short. The discrete price controls kick off in April and any people, process or system changes required won’t be achievable overnight.

When the market opens in April 2017, incumbents will be in a very different place. That’s three years away, but the decision-making deadline is pretty much now.