Until recently, competition has been a small yet discrete team in our office. Increasingly, however, as we look at our reform of how we regulate Scottish Water and the lessons that we have learned from watching retail competition develop, we see that these two work streams are merging.
The retail market ensures that retail activities focus on what customers need and are ultimately accountable (because they can lose customers) for the level of service that they provide. Initially, I had expected competition to be principally about larger customers wanting a reduction in their charges. In actual fact, the market has proven to be about smaller users and owners of larger property networks wanting more tailored services.
In my view three lessons can be drawn from this experience:
- Regulators may not be best placed to know what customers actually want (accessing the silent majority is far from easy).
- If there is space to innovate, a commercially minded company will seek to achieve the benefits that are available.
- Reputation is critical – and managements tend to respond quickly if their reputation is at risk.
These lessons are also fundamental to the changes we are seeking to make in the economic regulation of Scottish Water.
We want to empower Scottish Water and for it to take full ownership of its business plan and its customer service. As such it should be immediately accountable for its performance, and any shortfall in performance would impact on its reputation.
We want to empower customers. We are working with both Scottish Water and Consumer Focus Scotland to establish a Customer Forum. The Forum will be well placed to gather and synthesise the views of customers (of all shapes, sizes and locations) and negotiate the delivery of appropriate levels of service within the policy framework set by the Scottish Government.
So what then is the role of the economic regulator?
- To work with Scottish Water and other stakeholders to set out, before the business plan drafting process begins, some of the key planning assumptions that we would see as being reasonable. (This may include views on future base operating costs and capital maintenance, reasonable rates of return and other similarly high level, yet fundamental inputs to a business planning process.)
- To provide an objective view that customers and Scottish Water can draw on in coming to their view of the best combination of price and service.
- To set prices within the policy framework set by Ministers and the agreements reached between the Customer Forum and Scottish Water.
- To provide the space for innovation to happen.
- To facilitate planning for the longer term (for example providing certainty that longer term outcome delivery would be financed).
- To monitor and comment on the performance of Scottish Water against its regulatory contract.
- To monitor and comment on the Innovation Report that will be produced periodically by Scottish Water.
As regulator we act as a surrogate for the competitive market. This requires us to enable, be flexible, be adaptive and to encourage. It may also require us to set out areas where we consider performance has fallen short. But in essence the main driver of progress should be Scottish Water's determination to meet its customers' needs (whether that is retail or household customers).
I am quite often asked whether, with the benefit of hindsight, we would have done much differently in opening the retail market in Scotland. My answer is “no”. I appreciate that this answer may sound a bit arrogant. It is certainly not meant to imply that:
- We did not make mistakes in opening the market (we did!).
- We have not made changes to the operation of the market in the light of the operating experience of retailers and the wholesaler, and the service experience of customers. In fact, we have made many such changes and have actually just finished a review of the operation of the various codes that underpin the market.
- We do not think that there will need to be further changes if there is not to be an Anglo-Scottish retail market.
Looking back the most obvious mistake that we made was not to ensure that names, addresses and contact details were included in the central registration and settlement systems. But it was also unfortunate that we set an expectation that new entrants should take any customer, anywhere in Scotland, before having reached a critical mass. And no doubt we could have made it easier for a retailer to provide a different guarantee that it would meet its obligations more quickly (other than pre-payment) than we did!
I am however pleased that we got the big process issues right:
- We worked closely with Scottish Water, prospective retailers and customers in developing the market framework.
- We set a clear deadline for opening the market some four plus years into the future (and only just made it with a lot of help from both Scottish Water and Business Stream).
- We recognised that all stakeholders had to see benefits or at least no downside to the new market arrangements and that this involved not touching the RCV or the allowed for return, and ensuring that the wholesaler was pre-paid. It also involved rewarding the retailer with a modestly higher return in return for assuming all the bad debt risk.
- We responded flexibly when an element of the market framework was not leading to better outcomes for customers.
- The market participants and not the regulator are responsible for the day-to-day operation of the framework.
- The creation of retailers allows for more robust dialogue between the customer and asset-facing activities within the water industry, preparing the ground for greater innovation.
No doubt I should be more nuanced in my response about changing things but my defence is that the focus should be on the big strategic issues – not the detail of the framework.
My next blog will be on all the things that have changed since we first opened the market. Even a cursory review should make it clear that we are in a far different place today from where we were three and a half years ago!
There is a clear body of evidence that non-household customers have benefitted from the introduction of retail competition. We produced a definitive analysis of the reduction in costs achieved by Business Stream since it separated from Scottish Water. This was backed up by a detailed audit trail. We have also explained how this improvement actually came about from a lower observed level of costs than the average in England and Wales – admitting quickly, of course, that the baseline level of service offered to customers in Scotland was not as good as that available south of the border.
Separately, retailers, Policy Exchange and others have noted the benefits that have become available to non-household customers.
But what about the household customer? Should they be brought into the competitive market? Or are they simply going to have to settle for second best? It will not surprise you to know that I do not think that household customers should have to settle for second best. You may be a little surprised that I would not advocate adding households to the competitive retail market. But this does not mean that households will not benefit from competition – indeed, quite the contrary!
Greater focus within the wholesale business on meeting the needs of non-household customers reduces costs and leads to improved services across the board. Scottish Water's continued relative improvement in its wholesale business is a testament to what can be achieved when there is clarity in deliverables and in the regulatory and monitoring framework. This is a good start!
More important, again, is the facilitation of innovation in the industry that is brought about by the changed dynamic of a wholesaler working with a retailer. Such innovation will be critical in meeting the environmental challenges that lie ahead. It is also the best hope for all of us who want to see bills remain affordable.