The impact of AMP4 on supply chains
The levels of investment seen over recent AMP periods have resulted in well-developed supply chain strategies. However, the forthcoming shift in expenditure towards maintenance means main contractors will need to adapt if they are to see continued success, says Darren Munton.Since privatisation, regulatory bodies and customers alike have demanded that water companies deliver year-on-year improvements in the standards of environmental and water quality.
In previous AMP periods, these improvements have primarily been achieved through high levels of investment in large enhancement schemes in response to new legislative requirements such as the Urban Waste Water Treatment Directives.
Most of the water companies have now delivered the majority of the investment required to satisfy their obligations under such legislation and consequently, in the Regulatory Price Review for AMP4, the beginnings of a shift in investment from enhancement schemes to capital maintenance was in evidence.
Typically, investment in enhancement schemes has reduced by approximately 20% from the levels seen in AMP3, while investment in capital maintenance has increased in some cases by more than 40%. The graph (see opposite page) shows the typical breakdown of expenditure between AMP3 and AMP4, and the shift from enhancements to maintenance.
It is likely this shift in expenditure will continue into AMP5 as the water companies organise themselves to meet the requirements of the Common Framework for Capital Maintenance Planning.
The effect of the Common Framework will be that water companies will have to present significantly more robust business plans for capital maintenance than they were required to do in previous Price Reviews and consequently will be able to demonstrate the need for increased investment.
Although this does bring into question affordability and customer willingness to pay, this increase in investment is necessary to address the maintenance backlog brought about by insufficient funding being allowed in previous Price Reviews and to maintain the new assets delivered as part of the investment made to meet the recent legislative drivers in order to safeguard the environment, public health and ensure security of supply.
This shift in the focus of expenditure will have a significant impact on the supply chains of all water companies. Because of the levels of investment seen in enhancement programmes over recent AMP periods the supply chain strategies developed to deliver them are well developed and proactively managed.
However, these supply chains have been developed to deliver programmes of work consisting of large multimillion pound schemes and are not necessarily appropriate for the delivery of maintenance programmes consisting of a large volume of low-value schemes.
Typically, maintenance schemes range in value from just a few thousand pounds up to several hundred of thousand of pounds, with an average scheme being around £100,000 to £150,000.
The focus of investment on enhancement programmes coupled with the difficulties
of managing a large volume of low-value schemes, which vary widely in nature, has resulted in the supply chains used to deliver capital maintenance programmes frequently being left to evolve at a local level.
In most cases reactive and emergency capital maintenance is undertaken directly by the operations departments of the water companies together with a proportion of planned capital maintenance. Some planned capital maintenance is delivered by the external market however this is usually schemes of a complex or specialist nature or where it is sub-contracted by the in-house operations departments.
Typically, of the total capital maintenance expenditure, the ratio of expenditure delivered directly by in-house operators compared with that delivered by the external market is 40:60.
Of the value delivered by the external market, the significant proportion of this is delivered by regional and local contractors and/or specialist contractors with very little being delivered by the larger national main contractors.
Water companies now realise that not only do they have to improve the way they plan capital maintenance as a result of the requirements of the Common Framework, they also have to improve the way in which capital maintenance is delivered due to the increased proportion of their overall expenditure which is focused on this area.
The lack of proactive management of the supply chain used to deliver maintenance has frequently resulted in an inefficient, extended supply chain where procurement is admin intensive and traditional, and the performance of suppliers and contractors varies significantly.
Evidence from other sectors shows that by developing an appropriate supply chain strategy, which is proactively managed and by implementing robust commercial management of maintenance programmes, organisations can realise savings of up to 20%.
This will undoubtedly present opportunities for main contractors who have previously been involved in the delivery of enhancement programmes as the in-house operators will not always have the capacity or capability to cope with the increased levels of investment required necessitating the need to go to the external market.
However, it will not always be a straightforward move.
As the investment in enhancement programmes reduces, if main contractors are to maintain the share of the water sector market that they have enjoyed over previous AMP periods and not merely be used to manage the peaks of capital maintenance investment over the AMP period they will need to act now.
Main contractors need to reflect this shift in investment in their business plans now and identify how they intend to break into the capital maintenance market.
If they are to be successful they will have to be able to clearly demonstrate their ability to efficiently deliver maintenance programmes which involve a large volume of low-value schemes spread over a large geographic area. Furthermore, in order to be able to compete with in-house operations departments and smaller, regional and local contractors who do not carry the same level of overhead as the larger national contractors may have to re-organise their own organisations.
Water companies also need to play their part.
They need to look at how to get the best from the supply chain to support the delivery of their capital maintenance programmes.
For example, it may prove more cost-effective to award contracts for packages of similar types of maintenance requirements on a geographic or functional basis - ie. water or waste - rather than let each maintenance requirement in its own right.
This will undoubtedly play to the strengths of the larger contractors, ensure the market has the capacity to meet the investment requirements and reduce the amount of effort required in procuring maintenance suppliers and contractors.
The shift in expenditure from programmes of multimillion pound enhancement schemes to high volume low value maintenance programmes will impact on water companies and their supply chains alike.
It is in the interest of all parties to work together to organise the allocation of maintenance programmes in such a way that plays to the strengths of the of the supply chain in order to ensure the investment is delivered in the most cost effective manner.
Derek Munton is partner and Water Sector manager at EC Harris.