This blog first appeared as a guest blog for Utility Week on 28 January 2013

It is now more than a year since the Water White Paper was published. It is more than six months since we saw Defra's draft Water Bill. In that time there has been a lot of talk about what needs to be done, how it should be done, and when customers in England might be able to choose supplier.

Some commentators have recently started to speculate that there will be a delay in introducing the Bill to Parliament and that this would inevitably delay market opening beyond April 2017. It need not! What will be required, however, is a proper focus on implementing a retail market - doing not talking.

Our experience in Scotland was that passing the relevant legislation was not a particular pinch point on the road to implementing a retail market. For us, the first step was to have a clear and agreed vision of what the retail market should look like. So, which activities are retail? Who talks to whom? How does the money flow? How much profit is at stake? Who assumes working capital and bad debt risks?

Until a regulated company has a clear understanding of these things it is unlikely to be willing, or indeed able, to take any real steps in preparing for market opening. To do so could result in a series of false starts and much higher implementation costs.

Once consensus has been reached about what the retail market should look like, the next step is to finalise (at the price review) the wholesale and retail revenues that will be available to the current incumbents. The retail revenue would, no doubt, reflect an assumption that a company has 100% of its current customer base.

At the same time as this is going on, consideration also needs to be given to the development of appropriate market rules and procedures (or 'codes') that are critical to market opening. Only once these codes are in place can the benefits that flow from setting separate wholesale and retail charge caps be realised. (Incidentally these codes can be statutory or non-statutory - in Scotland we chose the latter.)

The initial focus should be on the two codes covering the key areas of operations and governance. The Operations Code should set out how the new retail function (and its competitors) will interact with the wholesale business (in essence how the two bits will be glued back together). The Governance Code sets out how a new entrant or customer can be sure that the incumbent retailer is not able to benefit at his expense.

The outcome of the price review will allow a company to begin work in earnest on how it plans to convert wholesale revenue into wholesale tariffs. This is not easy! Indeed it shouldn't be underestimated just how difficult this is likely to be - requiring the correct allocation of bad debt, working capital and indirect costs (such as the customer-facing costs of incidents) to different classes of customer. If a company gets these sums wrong it could make some of its customers unduly attractive to its competitors. This could result in the loss of profitable customers, the retention of unprofitable ones and losses in the retail business. Clearly this is not an attractive outcome (especially as companies are not able to exit the retail space).

A third code, the Market Code, will also then need to be put in place. It has three broad functions: to define the procedures for registering customers to a supplier, to calculate how much market participants owe to the wholesaler, and to set out the rules for the overall governance of the market (as well as how these can be changed). The first two of these functions are carried out by the CMA in Scotland. Their systems cannot be finalised until the wholesale tariff structure has been designed.

So is legal change a major constraint? Almost certainly not! Most, if not all, of what needs doing this side of the price review could be done (and have real value) as a regulatory initiative.

As to what might be required in actual legislation, key is losing the cost principle and ensuring that multi-lateral arrangements are possible. But the constraint is simply that these elements are commenced in the year or so before market opening. Indeed that is what happened in Scotland!

We organised a series of workshops on what we did in implementing retail competition in Scotland, why we did what we did and how we went about the task.  These workshops were well attended and I was pleased with both the number and quality of the questions that participants asked.

Perhaps the most important message was that, even if market opening happens only in April 2017 – much later than has been suggested – there is a very tight timeline that will have to be met. 
In essence this critical path divides into two halves:

• the period up to the setting of the wholesale revenue requirement of the incumbent businesses; and
• the period after the determination of charges is complete. 

Once the industry knows the wholesale revenue within which it will have to operate, it needs to develop – for the first time – a series of wholesale tariffs.  This is no easy task. It involves an improved understanding of the actual cost of serving different classes of customer.

The other big task is the creation and testing of central market systems – the registration of who supplies what customer and the settlement of wholesale charges. Ideally, more progress should be made in improving customer information than had been done in Scotland by market opening. But central system development cannot begin until definitive decisions have been taken about how the market will work and cannot be completed until the structure of wholesale charges and the market code have been finalised.

In Scotland we agreed a deadline for the opening of the market and were able to stick to this plan even when things got a bit rocky. It seems to me that a similar deadline is now needed for the opening of an Anglo-Scottish market. This would help focus all our minds on the most important issues.

The boy who cried wolf is an instructive fable, and an important lesson that we all should heed. But the lesson is not that there was no wolf. Rather, it is that it isn’t a good idea to claim you’ve seen a wolf when actually all you saw was a sheep!

So it is with implementing retail competition in the water industry. I can understand that a monopoly company is always likely to be unwilling to give up even a relatively small part of its monopoly. It will fight its corner. It will warn of potential consequences. It will cry “wolf!”

But just because it cried “wolf” in the initial policy debate, this does not necessarily mean that it is crying “wolf” in discussions on how the framework proposed in the Water White Paper may be implemented.

If anything, my view, from our experience of having implemented a similar, if smaller scale framework in Scotland, is that the industry may actually now be mistaking a potential wolf for a sheep. It seems to be underestimating the time and effort that will be required to ensure that non-household customers have a choice of supplier.

In Scotland we set April 2008 as the date for market opening. We did so in 2004 when the Water Services (Scotland) Act was well through the parliamentary scrutiny process.  Achieving market opening was challenging. We coped well, I think, with most of the challenges that we faced. But even so we did not have the time for parallel running of systems and processes that I would have liked to have.

There are four particularly challenging implementation issues:

• Competitive retail tariffs will have to be developed, reflecting appropriate retail cost drivers and scope for savings (for example, bad debt charges for different classes of customer). There will inevitably be trade-offs between how wholesale charges are constructed and the ‘default’ retail tariffs that the retailers will be happy to offer. In the multi-wholesaler world, south of the border, this could be more challenging than it was in Scotland. Incumbents’ retail businesses may seek out anomalies. If governance arrangements ensuring a level playing field are ineffective there may be an opportunity to establish default retail tariffs that are unattractive to retailers from other areas.
• Wholesale charges will need to be designed. The definition of wholesale activities and the results of the next price review will need to be taken into account, as will the appropriate retail margin for each customer class. In Scotland, working closely with Scottish Water, this process took well in excess of a year. This would suggest that even if there are no appeals to Ofwat’s determinations, wholesale tariffs could not be in place before the end of 2015.  These new tariffs need then to be incorporated into the settlement systems – perhaps a six-month process. This takes us to the summer of 2016.
• Registration and settlement processes are fundamental to a smoothly functioning market, allowing wholesale charges to be calculated and retailers to transfer customers. Transparent governance rules are also key to efficient market entry, exit and alteration of market codes. Much of this can be done in parallel with the development of wholesale charges and other elements of the market arrangements. But they cannot be finalised without the Governance Code and the final version of the wholesale charges.
• Any data accuracy issues (around definition of premises and information on customers, particularly with regard to connection type) will need to be improved before market opening – otherwise the effectiveness of the market is reduced. With hindsight, WICS and other stakeholders in Scotland could have paid more attention to this issue. We are about to embark on a root and branch review of customer data (involving all market participants) in order to ensure that the information on customers is as accurate and as consistent as it ought to be. I now wonder whether it takes time for all parties to realise the downside for them of inaccurate information before a proper data cleanse can be achieved...

Perhaps my message is: “Beware the wolf in sheep’s clothing!” It will not help anyone if companies are not given the time and space to make the changes that they will have to make. Any deadline should be challenging – but it is only truly challenging if it is seen to be realistic.  The message of the fable is clear: do not confuse the false warnings of a wolf with the false certainty that there is no wolf!