There is much debate about whether, and to what extent, economies of scope exist in a vertically integrated wholesale and retail water and sewerage company. A further question is the extent to which such economies of scope are lost if retail activities are managed separately from the wholesale business. And a further question again as to whether savings resulting from separate operation may offset any demonstrated loss of economies of scope.
I am not convinced that there is a robust, unchallengeable answer to these questions.
What is clear, however, given the evidence from Scotland – both in terms of the level of service provided to non-household businesses and the reductions in costs that have been achieved by Scottish Water and Business Stream since they began to be operated separately – is that there are potential gains (in terms of level of service and cost reductions) that may benefit customers.
A comparison of the retail costs declared by the water and sewerage companies south of the border with those of Business Stream before separation suggests that they are higher. This may reasonably be explained by the better level of service that was provided to non-household customers by the privatised companies in 2006-07. But Business Stream has now reduced its costs by more than £8 million a year and, according to its customers, the level of service now provided compares well with that available elsewhere in Britain.
At the same time Scottish Water has been reducing its costs ahead of its regulatory targets.
This could lead to a conclusion that there is no loss of economies of scope as a result of separating wholesale and retail activities. But it is possible that there have been other effects, not currently observed, which are detrimental and which offset the cost advantages seen in Scotland.
One frequent objection to operating retail and wholesale activities separately is that the industry would be likely to respond less effectively in the event of an emergency. The argument would likely continue that given the importance of an effective response to an emergency, wholesale and retail activities should remain vertically integrated – whatever the potential savings or benefits in terms of customer service or environmental improvement.
But there is evidence on dealing with emergencies available from Scotland. Since separation in 2006-07, there have been two of the coldest winters in recent times. However, both Scottish Water and Business Stream stepped up to meet the challenges presented by such extreme conditions – not least the challenge of dealing with non-household customers during a holiday period when the normal occupier of a premises may not be easily contactable. Certainly their response and those of the other licensed providers would seem to compare favourably with other areas of the country.
Of course, this does not mean that the separated activities will always be able to respond as effectively to every emergency. And while I have no reason to be worried about market participants' understanding of how to deal with emergencies, one of the conclusions of our competition framework review is that we should issue a clear, high level statement of our expectations and the responsibilities set out in the Operational Code.
To conclude, are there economies of scope? Neither I nor anyone else can be sure! But the onus is surely on those who assert their existence to prove it – particularly in the light of the evidence from Scotland.