A determination to end stop/go
To get a picture of the problems facing the industry's suppliers and contractors, and how the situation can be eased, WWT spoke to Paul Mullord, commercial manager with British WaterWWT: Many of the current concerns seem rooted in the water companies' reaction to the severity of Ian Byatt's final determination. Did they underestimate his determination to enforce the cuts?
PM: I do not think they wanted to believe he was serious. With AMP2 there had been more of a negotiation. It was a shock to the water companies that he stuck to those figures, which I think represented about a 30% efficiency saving.
But you should also remember the first deadline for the Urban Waste Water Treatment Directive almost coincided with the end of the periodic review. Water companies also faced a major change in the type of work they had to do which had major implications.
Firstly about 11,000 people were laid off which had two effects. The instability
made the industry less appealing to graduates and water companies were forced
to outsource a great deal more work.
Secondly, water companies reviewed their engineering plans to see how money could be saved, which meant a lot of tendering work with no guarantee of contracts at the end of it. With all this optioneering our members were faced with working without payment.
Thirdly, the way water companies worked with contractors and suppliers came under review, partly due to the periodic review, partly due to changes in the type of work. Most utilities opted to work closely with fewer suppliers. Anglian, for example, cut its supplier list from 250 to single figures.
WWT: How common was this situation?
PM: Almost universal, the whole thing was turned on its head. While the utilities were doing this re-planning, and because they did not know who they were going to be using, very little work was done, apart from the tendering. So while our members did not reduce their workforces drastically, the type of people they needed was different. This, coupled with graduate recruitment difficulties and the loss of people to the other sectors has led to staffing problems.
To retain staff, contractors have been forced to increase wage levels. This extra expense has made it difficult to meet quotations given at the beginning of the AMP3 process, without losing money. If the opportunity to re-quote for work arises rates are likely to increase. And we have seen that happen.
There is a tendency for water companies to go out to tender, get a price, compare it with their original expectations and find the price has increased. Then, rather than bite the bullet and pay the extra, they go back into the tendering loop and look for ways to get the price back down. But if they cannot find a cheaper way, they often find the initial bidder has raised prices in the interim.
WWT: What other factors are increasing costs?
PM: There is also a shortage of certain materials, some types of pipe for example. This impacts upon your programme because if you cannot finish a job because you lack materials, you have to re-schedule other work which impacts on your efficiency.
WWT: What is causing the shortages?
PM: Very high demand. For example, having spent a year planning, United Utilities has gone from spending nearly nothing to £50M per month. This has happened in the last three to four months.
There will always be a lag between placing of a contract and orders getting to suppliers, but the drastic fluctuations in demand we have seen makes shortages inevitable, which means some work is being turned away. If you put out a competitive tender, ask for three bids and get one back, price rises are almost certain.
WWT: Are the costs significantly higher than the water companies anticipated?
PM: High enough for them not to place the orders.
WWT: And while they look around for cheaper alternatives, the cost is likely to increase further?
PM: Inflation is always going to be a factor. If you can not find a cheaper way of engineering something and return to the same design six months later, if nothing else inflation will have driven costs up.
MH: When they repeatedly re-tender hoping work will get cheaper are water
companies being unrealistic?
PM: They would like to think the initial solution is the optimum one, but realise there is usually more than one way to achieve something. It could be a change in the process, for example, which means going to different contractors.
There are a number of ways to save money, but they are often included in the second costing. Utilities will have had one price for the AMP, a second to try and save money - which already means two looks at a single project. There is going to be a limit to how many reviews they can undertake. You can not keep on saving money, if you can you are doing something wrong in the first place. You are not working efficiently.
WWT: So is re-tendering increasing back-end loading and the cost of the work?
PM: Yes, but another factor is deadlines. Under the present regime it makes little financial sense for utilities to undertake work a long time before it needs to be completed.
It would be better for our members if the allocation of projects took greater account of logistical and operational efficiencies. Unfortunately, all the financial director often sees is the bottom line and if he believes he is incurring expenses earlier than he knows he needs to, he'll resist it.
WWT: What will the net effect of the skills shortage and back-end loading be?
PM: To achieve the targets they have been set, water companies should be using the most cost-effective designs and managing projects so the same solution can be used on many sites. This allows engineering teams to get used to a system of working and creates economies of scale. Work can be done efficiently with one team moving from one job to the next, hopefully in a sequence which allows plant and equipment to be moved just in time for it to be used.
I think you would be hard-pressed to argue against this as one way of achieving the efficiency savings the regulator has asked for, but it is not happening. The current approach is causing contractors to do several jobs at once, using people new to the industry who are not necessarily of the highest calibre.
WWT: Is the use of less-qualified people a significant problem?
PM: Yes. People new to the sector will obviously be unable to contribute as much as the skilled people we were forced to let go of a year ago. We had this problem, on a smaller scale, ten years ago when there was a shortage of construction projects and civil contractors looked to recently-privitised water companies for work. The contractors were inexperienced which resulted in problems which had to be put right - which cost money and time.
All these factors add up to inefficiencies. If you want to, you can think of
it as money which has to be paid in
addition to the amount originally budgeted.
Think back to the original object of the exercise, to reduce costs. The point of Ofwat's price cuts was to try and force the water companies to save money by operating more efficiently. But the whole process of doing this has created a lump of new inefficiencies. The regulator has told us he believes over five years things will even out and the cost of these new inefficiencies will be less than the efficiency savings planned initially.
WWT: The regulator seems to see the problem as less troubling than you. Do you think he underestimates it?
PM: I doubt Philip Fletcher is looking at it from the same perspective as we are. It is very easy to play the figure game with a spreadsheet and say it will work out in the end.
It is British Water's members' livelihoods, it is the well-being of the industry and it is the ability of this industry to compete overseas for UK plc that is under threat. All those things are of great concern to us and our members.
WWT: Do you share the fears of some that these problems will impact on the ability to complete AMP3 projects on schedule?
PM: I do not know. I would suggest that at the end of the day, if there is a shortage of resources it will cause you problems. But I would also say that if you pay enough money you will get the job done.
If we could do it without incurring all this extra cost by introducing new inefficiencies into the system the net result would be better.
WWT: How real is the problem of back-end loading?
PM: Philip Fletcher says there is no back-end loading, but if you do not spend in the first year of a five-year programme and do in the latter years, that is back-end loading. It is not planned, but it happens.
WWT: What is best way to encourage a more stable environment?
PM: In some areas there is already pressure to release money to do work in the first year of AMP4, it is already in the determination.
It would also help if the determination was announced earlier, making it possible to undertake planning and organising at same time as contracts are still going through. Staggering the work for each water company could also have some benefits, although I appreciate this might cause problems in comparing one water company's performance against another's.
WWT: My impression from Ofwat is that the regulator felt plenty of warnings about the final determination were given, but the industry ignored or choose not to believe the warnings.
PM: OK, then perhaps it should not be a warning, but an early announcement of the final determination. If the last determination had been announced in 1998 rather than 1999, water companies could have been preparing for AMP3 while they were finishing AMP2 projects.
WWT: Surely water companies would have to take on more people to make this possible. In an era of lean thinking and outsourcing, do you think they would accept the need for people in such a forward planning role?
PM: They would probably see it as additional cost. If you talk to them they take on board all of these arguments, but in the end it is the money which counts.
WWT: So change is unlikely?
PM: We are trying to get our message across. We have shown Philip Fletcher the fluctuating order profiles our members have to cope with and asked him what he would do in their shoes.
WWT: And his response?
PM He did not jump out the window [laughs]. But its real, it's not a game. CAPEX is real, its people doing a job of work, its companies trying to keep people employed and make a profit. And if your order intake falls by half in the space of a year and stays there it is very difficult to remain focussed, to remain in business and that point just seems to get missed.
WWT: That holds true for companies in most fields.
PM: Yes, but with water you compound the natural tendency for this to happen with a regulatory regime which means you can not get business - there are not any orders to get because of the periodic review process. We are not asking for a handout or a free ride, we are saying the regulatory process in many cases damages the efficiencies it is trying to achieve.
WWT: So does the crux lie in the nature of regulatory set-up, with back-end loading just one symptom?
PM: If you regulate an industry through comparative competition, and set-up a process which sets prices and schedules of work, it is inevitable you will get this stop-go effect. I do not know what could replace it, but there are some things you can do to ease it.
WWT: What action has the regulator taken to ease the situation?
PM: He acknowledged the problem. In next the review he said he would try to
even out peaks and troughs. He has given us an input into the process we never
had with Byatt. That is progress.