Cutting out inefficiencies and creating sustainability
A key challenge for the water companies is how to encourage contractors to plan for the longer term by building stronger supply. One possible solution, says Terry Povall, may be to provide incentives now for the building of sustainable supply chains that can be passed onto future contractors.Following privatisation in the early 1990s, the water companies through intensive value engineering processes initially achieved primary reductions in capex and opex costs. As the drive for continued cost savings continued this was followed by the building of closer working relationships with first tier suppliers, which led to increased efficiencies arising out of collaborative working and consequently lower outturn costs.
At the time of the engagement and embedding of these new working practices in the sector in the mid-1990s EC Harris undertook for several clients a review of their supplier spend.
This revealed that 40 to 70% of total spend in the sector was being supplied through numerous supply arrangements, with no synergy or leverage.
Initial benchmarking identified and highlighted the need for better engagement of the supply chain at all levels in order to maximise performance and leverage across clients and contractors businesses.
On the back of similar findings across the sector it can be said that every major water company has over the past ten years carried out some sort of supply chain initiative in an attempt to harness potential savings arising out of:
- Synergies of supply and leverage across the geographical working areas achieved through improved and open working relationships
- Improvement in speed of delivery as well as compliance with key programmes (just-in-time philosophy)
- A structured purchasing strategy that ensures increased efficiency by minimising waste, whilst ensuring a quick response to change management and project needs
- Accurate budgeting and prompt payments leading to lower outturn costs (capex and opex by up to 30%), thus minimising disputes within the supply chain
- Standardisation of key equipment and procurement approach in order to maximise savings in supply, installation and operation
- Sensible use of KPIs to enhance the drive for improvement
- Guaranteed workload for key suppliers enabling a trained efficient workforce to be maintained
Whilst the industry as a whole has been very successful since privatisation at being more efficient what might be regarded as the easy efficiencies have now been made and it is not clear where further efficiencies are to come from. The supply chain is one of these areas, and the question has to be asked as to the extent to which we have an efficient supply chain.
Throughout previous AMP periods many industry leaders have often stated that early involvement in the supply chain is crucial if the industry is going to deliver smarter. However facing the fact that several water companies have maintained the same partners in AMP4 as AMP3 this in theory should have given them the opportunity for that early involvement.
Nevertheless many first tier partners have failed to carry over benefits from AMP3 into AMP4, and are now revisiting their own supply chains. In addition, the formulation of new procurement strategies has also caused supply chain relationships to be lost.
Consequently there is clear evidence that at the interface between the water and sewerage companies and their suppliers' collaborative arrangements are working well. However, there is less evidence of this further down the supply chain.
British Water surveyed recently the best water companies, under the headings:
- Contractual approach
- Impact on the supply chain
It revealed that several companies who are highlighted in the sector as having successful collaborative arrangements over previous AMP periods were scored in the lower quartile. This provides a clear indication that the supply chain is still ineffective at the lower levels even where apparently successful collaborative arrangements prevail at the first tier.
Some of the reasons for this are that despite several companies being successful on successive AMP programmes the commitment from the water companies was only to the previous five-year programme, with only a window of opportunity for the next five years.
Consequently contractors could only look to a commitment of five years' work. With the lack of commitment for future work, contractors were quite rightly geared to maximising profit in the current period rather than supporting the water companies in building a longer term sustainable supply chain as they may subsequently not feel the benefit of this should they lose the future work.
As an example, EC Harris has experience of one contractor who used more then 15 different suppliers for a single service provision in AMP3, as he drove for the lowest cost solution, and is now using a completely different set of suppliers for the same provision in AMP4. In addition, not all water companies were consistent in re-awarding AMP4 to the previous AMP3 contractors, and some companies completely changed their tier one-supplier list, which challenges the point about their own commitment to sustainability of the supply chain.
How can any supplier or contractor be expected to invest in research and innovation without security of future workload over a five-year period?
One area that is working well is that many water companies have direct agreements with key equipment suppliers and quality of service and supply delivery has given these suppliers a confidence about the ability to secure future workload. This has enabled them to invest in such areas.
The problem is more difficult around those second and third tier suppliers that are mostly procured through main contractors, and who are further down the food chain.
A recent analysis of spend in this part of the supply chain revealed that 70% of cost incurred by a main contractor was in fact cost passed through to these lower tiers, and there was no effective supply chain in place.
It is in this area where the future development and efficient management of the supply chain is seen as a key challenge, and where there are still potential gains to be had.
One of the key problems is that the cyclical nature of the regulatory process and subsequent release of work creates peaks and troughs, which have a major impact on the supply chain. Resources, in particular labour and professional resources, which are needed to meet the peaks cannot be used in the troughs and while the larger firms can stand some of these under utilisation costs the smaller firms are unable to retain these resource.
Professional staff and labour that can move to other industries during the period of low demand often do so and some have reported that rewards are better which create barriers to returns.
The situation with basic construction materials is even more serious - as all water and sewerage companies are on the same workload cycle this means that the whole sector is working either flat out or short of resources and experiencing higher prices.
In the future the risk of supplies of basic construction materials, such as pipes, re-bar, aggregates and plant, and the risk of price hikes will become even more critical. Over the next five to ten years expected infrastructure spend across the country from projects like the Olympics, Cross Rail and infrastructure generally will put added pressure on the second and third tier supply chain that provide these basic materials.
The main problem for the supply chain is not only that the current regulatory regime for the periodic review creates a boom and bust cycle for the supply chain, but that water companies link their procurement strategies to the same review period, and adopt successive competitive tendering to drive prices down.
An example of this was the reverse auction practices adopted by several water companies in AMP3.
Is it understandable therefore that contractors forced into such a financial climate will ignore the long-term benefits of an effective supply chain and adopt similar practices.
The real needs of the biggest element of the supply chain seem to have been ignored.
Some will argue that this is how it has always been since privatisation and there is a culture of acceptance but the benefits cannot be ignored.
With no one counting the total cost of the impact of this, an analysis undertaken by EC Harris of such potential within one capital programme revealed savings in excess of £100M. With clear evidence of what can be done with the supply chain coming out of the longer term projects such as Terminal 5 these savings have to be achievable.
There are many who are lobbying for changes in advance of the next price review advocating changes such as including more work in the early start programmes, the levelling out of workload and decoupling procurement from the regulatory cycle.
OFWAT has put some good arguments for retaining the five-year cycle around the principle that the further one projects the less accurate are the projections.
So, if there is little likelihood of changes in the regulatory periods then the only cause of action is to manage the supply chain better within the five-year period but at the same time building a more solid platform for the future.
One of the keys challenges has to be how to encourage contractors to plan for longer term by building stronger supply chains now even in the face of the possibility that they might not get future work beyond the current period. One solution may be to provide incentives now for building sustainable supply chains that can be passed onto future contractors.
However there is the added benefit that if a contractor sets out to build such a platform in a current AMP period should this not enhance the value of his capability and put him in an excellent position for securing future work.
EC Harris believes changes by OFWAT and the water companies may have some impact.
However, the tier one contractors have to take the initiative if the whole supply chain is to be involved, and if innovation and continual improvement, which have been headlined in the sector for many years, are to start showing real evidence in
supply chain management within this sector.
Terry Povall is head of water at EC Harris. T: 0151 243 8490. E: firstname.lastname@example.org