The case for change adds up

British Water has arrived at a new solution for the impact of the AMP cycle on the supply chain. Paul Mullord, the UK director for the industry body, explains why splitting water and sewage makes sense

In October, Ofwat published its report on the Financial Performance & Expenditure of the Water Companies in England and Wales 2009-2010 (FPE). This year's report completes the data for AMP4, showing the profile of expenditure during the whole AMP, allowing it to be compared with previous AMPs.

The graph shows a depressingly familiar and damaging profile of expenditure that the supply chain has been subjected to since the industry was privatised over 20 years ago. Despite efforts made by some of the companies to flatten the profile and some changes to the review process made by the regulator, the outcome has been disappointingly predictable.

British Water recently asked its members to supply data on how the five year cycle shown above impacted on their businesses in terms of resources. The question was very simple and related to the number of people employed by them working directly (or indirectly as contractor, sub-contractor or supplier) in the regulated water industry in England and Wales at the start, peak and end of AMP4.

The results are alarming, showing that the number employed at the start and finish of AMP4 is 40% less than at the peak. Estimates published in Autumn 2004 (1) suggested that there were 100,000 jobs in the water industry supply chain. If that number represents the maximum number employed, then the number of jobs gained and then lost is more than 40,000. The Chartered Institute of Personnel & Development (2) estimates the average cost of redundancy, replacement and training to be £16,375. This would indicate that the cost to be approximately £650M for AMP4 or a staggering £2.6B since privatisation and well over £3.25bn before the end of AMP5. This figure does not reflect the hidden costs and intangibles associated with a variable workforce. These include:
  • The cost of employers having to maintain equipment, buildings and infrastructure to accommodate the maximum number of employees rather than the average
  • The cost of knowledge and experience lost to the industry when people leave and do not return
  • The cost to society of supporting 40,000 extra jobless, albeit (hopefully) temporarily
  • The human cost and stress to individuals and families brought about by this process.
A fluctuating workload also impacts the resources that are retained. During downturns, valuable staff are often deployed to lower skilled jobs and during upturns, extended working hours and overtime are often required. Increasing the numbers of contract staff to deal with the peaks is an option, but this can be costly in terms of total payment, commitment and efficiency. Additionally, companies are less able to negotiate market-leading purchasing terms and, being seen as a high risk, they face higher interest rates than might arise otherwise. There is also a need to carry more stock to meet demand - thus tying-up capital and the efficiency of many manufacturing processes and the transport of raw materials and finished product is often compromised.

Due to a lack of turnover and the need to continually manage resources, companies are unable to plan and implement healthy business strategies to improve performance and competitiveness. These include innovation, product development, and diversifying into other markets or sectors. Huge cost savings can be made by flattening the profile of expenditure, not to mention the long-term sustainability and viability of the supply chain and its capacity to fulfil its potential in the international market place.

The idea is not new, but as the graph clearly shows, little has changed in the 20 years since privatisation. There have been suggestions made as to how the regulatory structure might be changed to allow or encourage the profile to be flattened. One has been to stagger the Periodic Review of prices so that not all water companies undergo the review at the same time. Ofwat has resisted this proposal, saying that it would result in a loss of comparators and undermine the regulatory process.

A less radical alternative would be to separate and stagger the review of prices for water and for sewage. The two services are reported separately in the FPE, coincidental comparators would be retained and the effect on the profile would be significant. The graph below shows the profile of expenditure that would have been seen if the reviews of water and sewage services for AMP3 and AMP4 had been staggered.

There are only two sources of revenue in the industry that flow through the water companies and down the supply chain: the water companies' customers and their investors. It can be assumed that customers would be happy with the lower bills ensuing from greater industry efficiencies, but investors need to be assured that any changes to the regulatory structure will not adversely affect the stability or security of their investment.

There is a danger that in the ongoing Defra review of Ofwat and the resulting White Paper, no changes will be proposed for fear that any change might upset the delicate balance of investor confidence. Perhaps a simple change such as separating and staggering the review of water and sewage services might be a change that can benefit all of the industry stakeholders and gain their collective support.

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