Water Charges and Procurement
The second item of business is further evidence from Scottish Water representatives, this time on the “Strategic review of charges 2015-21”. The session will include questions on Scottish Water’s engagement in the process, including its related draft business plan from 2015 to 2021.
We will also take the opportunity to ask Scottish Water about its procurement activity, given our current scrutiny of the Procurement Reform (Scotland) Bill.
I again welcome Douglas Millican, chief executive; Ronnie Mercer, chairman; and Peter Farrer, chief operating officer, from Scottish Water; and Mark Powles, chief executive officer of Scottish Water Business Stream.
Perhaps Ronnie Mercer would like to make a short statement.
I will take just a couple of minutes—thank you, convener.
Scottish Water is very keen to build on the successes of our unique public sector model and to progress the interests of our customers within that. The model is largely different from the model in the rest of the UK, but we think that it is working quite well.
We are trying to embed in the business the efficiencies that would be made in a private company; the productivity that we want and the commercial edge that we need when we spend the money that we do; and the customer service that our customers deserve.
At the same time, we are trying to achieve the outcomes set by our owner, which is the Government, to meet all its directives, and to recycle any gains that we make in the business from beating the regulatory contract back into the business instead of sending them off somewhere else. We are really keen to make that work.
We have just held our largest ever consultation, “Your views count: shaping the future of water and waste water services”, to decide what our strategic projections might be and what those services will look like over the next 25 years.
We have conducted pretty extensive research, we have been heavily influenced by customers, regulators and stakeholders, and we have a customer forum. Peter Peacock, lately of this parish, is heading that. I met him a couple of weeks ago at a seminar and he asked, “What’s keeping you busy, Ronnie?” and I said, “You are, Peter.” His forum has had a big input, but that is what we wanted, and I hope that we will make that work for us.
We have recently published the strategic projections for what might happen over 25 years, and we have just produced a draft business plan for the six years that you mentioned in your opening remarks, from 2015 to 2021. I am now focused on what we are going to do about that, and we are due to meet the regulator at the beginning of December to start the process. The process will be quite long as a lot of discussion will be required before we eventually agree a final plan, which should serve the best interests of the customers and the long-term requirements of the industry with prices that are affordable.
What are the key messages that we get from customers’ input and from the customer forum? First of all, they tell us that we cannot compromise the existing service levels; nobody is going to accept anything going backwards. They rightly expect that they will always have a safe and reliable supply of water and that their waste water will be taken away and dealt with properly, so that is a given. They are looking for further improved services, but they do not want large price increases to go with that, so we must ask what we can do for fairly modest increases.
We have looked at that input, and we think that we can commit ourselves to reducing charges in real terms and limiting further charges to less than the rate of inflation for the six-year period that has been mentioned. That is where we have started as the basis for the plan.
Looking to the future, we want to be operationally proactive on preventative measures. We have just opened a new intelligent control centre, which takes in messages from all over Scotland using telemetry, alerts and alarms, and tries to seek out and prevent problems from happening rather than merely responding—although of course we have to be responsive if something happens.
We expect that capital spending will remain at around £500 million, at 2012-13 prices, to cover increased capital maintenance and to invest in services. That includes investment to address flooding from the sewers. There will be a bigger emphasis on that issue, as it is one of the things that customers stress heavily to us.
Improved resilience in the water network is something that has already been asked about. It is strange that in a country where it rains a lot we sometimes have to issue warnings about not washing cars, but that happens. We have to manage or move water resources more effectively, even in Scotland, to meet customers’ needs.
Based on our partnering experience in Glasgow, via the long-named metropolitan Glasgow strategic drainage partnership—not an easy trip off the tongue—where £250 million is going to be spent, we can achieve better outcomes at lower costs. Significantly, the best £10 million of that £250 million was spent before we started, on measuring, modelling and studying all the things that happen, so that we did not waste money by starting and then realising that there was input somewhere else in the system. That work is all being done, so we can build on it.
What I have just mentioned is to do with Scottish Water. For Business Stream, we anticipate increased competitive pressure; that is a given. The Westminster Government’s new legislation and reforms are going through, and there is a significant opportunity for Business Stream, because there is a £2 billion market that we can try to get a bit of—and we would like to think that we can do that. Mark Powles has already said that the situation is not quite level at the moment; we have an open market and England and Wales do not, but that will change and we must try to hang in there until it happens.
Business Stream has created a pretty strong brand. The strategy right now is to defend it up here and to get into position—we could have a first mover advantage, having been in the market for years before everybody else, which I hope will work for us—while trying to maintain the customer experience. That is generally what Business Stream is trying to do.
I hope that those comments give members some insight into the future of both Scottish Water and Business Stream and what they will try to tackle over the next six years of the plan.
Thank you. Jim Eadie will start off the questions.
Let me say at the outset that I represent an Edinburgh constituency and my experience confirms what Ronnie Mercer has just said about Scottish Water being influenced by its customers. Mr Farrer is aware of the background to the issue, and I put on record my appreciation for the constructive discussions that we have had, which I think will deliver a very positive outcome for my constituents very soon.
Let me ask about the timeline for the strategic review. When between now and April 2015 can we expect new charges to take effect?
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The new charges will start in April 2015 and we give ourselves the next year—2014—to prepare, although we hope that we will not need as long as that. It will be a bit of time, but I am not quite sure how long at the moment. What do you think, Douglas?
We issued our draft business plan at the end of October, which has gone to all stakeholders to consider, but primarily to the Water Industry Commission for Scotland, the quality regulators and the customer forum.
We hope to agree a business plan with the customer forum by February 2014. If we manage to do that, or even if we do not, in April 2014 the Water Industry Commission will issue its draft determination of charges, which will be its view of charges. That will be open to public consultation until June. Over that period, we expect the Scottish ministers to confirm their investment objectives, their charging principles and the level of available borrowing.
The Water Industry Commission will then be able to take all that into account, including the consultation feedback on the draft determination, to produce a final determination of charges that will be published in November 2014. As Ronnie Mercer mentioned, charges will apply from April 2015 onwards.
I will come to the detail of the business plan, but I will stay on the process for the moment. Has there been any input on the development of the business plan? I know that you are saying that you are about to consult and engage in an extensive consultation period. However, have the Water Industry Commission for Scotland and the customer forum been involved at the initial stage?
There has been huge involvement from many parties. It may be worth me taking a couple of minutes to explain what has happened.
The first step was that the Water Industry Commission launched a review of how regulation of the Scottish water industry could be enhanced. It focused on three themes. First, did the commission need to review how incentives operated on Scottish Water and the parties in the industry to drive the best outcomes for customers? Secondly, how could much greater levels of innovation be brought into the plans that Scottish Water comes up with? Thirdly, how could customers be much more involved in creating the future of water services?
That three-pronged approach has driven a major programme of work. The first stage was to produce a draft of the strategic projections, which was published in October last year. The production of that draft was very much informed by working with the customer forum and other stakeholders. The draft went out to public consultation. We also had the your views count exercise for customers that Ronnie Mercer mentioned, through which we received a lot of feedback in the period to February this year.
We then worked extensively with the parties that you mentioned, particularly the customer forum, when we were shaping up the draft of the business plan that we published. For example, over spring and early summer this year we produced a series of service improvement reports that set out, for an area such as drinking water quality, the nature of the current service provision, the nature of future challenges and the options that are available for meeting those challenges and the degree of choice that customers have over them. That has informed very much our drinking water quality improvement plan, which is partly about meeting statutory requirements but also about meeting customers’ expectations for and trust in the reliability of the drinking water service.
The plan absolutely reflects the huge amount of feedback that we have had from stakeholders and the extensive customer engagement programme that we have carried out.
That is very helpful.
How have you involved Scottish Water customers when developing the plan and do you intend to continue to involve them as the plan is rolled out? I am thinking specifically of the investment plan, which will be updated on a rolling, three-year basis.
There have been many dimensions to our involvement of customers. I draw the committee’s attention to the draft plan on pages 5 to 7, particularly page 5, which sets out a summary of all the dimensions that we have used. They range from having groups of customers sitting in a room for a two-hour facilitated conversation, through to having surveys done in which customers can engage online.
We have built on the extensive feedback that we get from customers as part of their normal engagement with us on services. The customer forum has done its own validation of that research. We have a multiplicity of channels.
It was encouraging that there was a huge degree of commonality of views in our research, which was validated by the customer forum. It was really helpful for us that the forum held the lens up perhaps slightly differently. For example, we might have said, “Our research shows that customers are willing for prices to rise by a little.” The forum said that, while it had come to the same basic research conclusions, it had a slightly different take on them. It did not think that the issue was so much that customers were willing for prices to rise; it was more an acceptance—maybe a slightly reluctant acceptance—that to get the improvements that customers wanted prices would probably need to nudge up a bit. It is because of such nuances of customer feedback that we are really beginning to understand what matters to customers. That is for now.
For the future, and the investment review update in 2018, we believe that we have a pretty good understanding of what some of the key areas of investment focus will be, but we will engage with customer groups, the forum if it continues and the consumer representative bodies as well as customers directly, to understand whether we need to adapt those plans, depending on what happens over the next three or four years.
That is very helpful.
Finally, will you share with the committee what you see as the key challenges facing Scottish Water across the range of issues that you are engaged with, as set out in the business plan?
At the very highest level, one of the challenges will be to meet customer service expectations for the lowest possible cost. That is the crux of it. As Ronnie Mercer mentioned in his opening remarks, customers take for granted the reliability of the service, and we need to invest to maintain that basic service provision.
There are a number of areas in which customers would like us to make improvements to deal with issues such as sewer flooding, drinking water quality and improving the resilience of the system so that they will never have to suffer an extended period of supply interruption. However, they want us to do that in a way in which price changes can be held below the rate of inflation.
On the increased competitive pressure that you spoke about earlier, what do you see as the key threat or challenge facing Scottish Water?
Scottish Water Business Stream now has 12 more competitors. There is nowhere else to go at the moment except here, because the market is not really open in England and the little bit that is open has no margin. That is why nothing is changing hands.
If I were the English water companies, I would be up here learning so that, when the market opens there, I can defend my own patch and maybe try to attack someone else’s. We are getting them flooding in—to use a pun—because they are looking both to get some business up here and to get used to the whole idea.
Would you like to add anything to that, Mark? You are having to defend it all.
That is what competitive markets are all about. If the service is not very good, the customer will go elsewhere. As Douglas Millican said, in the core business it is about service and price, and—I would add—innovation. A lot of customers make a price decision and others make a decision based on service. However, others make a decision based on how proactive and innovative a business can be in solving their problems.
What we have tried to do over the past five years is to recognise customers and their individual needs. For example, the needs of a multisite retailer are very different from the needs of a council. We are starting to tailor services to customers.
There is nothing like the fear of losing a customer to get you to raise your game. I spend most of my time looking over my shoulder wondering whether somebody is going to do something that we have not thought of. That drives us to try to do more.
The benefit for Scottish customers is that we stay focused on doing great things for them, and another benefit is that we can take those propositions into new markets as they emerge. The fear of losing a customer is a great motivation for us to wake up and be on our game in the morning.
I am sorry that I missed your initial presentation, gentlemen, but I have been very interested in what you have had to say. I will ask about some of the financial issues. Given the investment needs that are set out in the draft business plan, I would be grateful if you could specify exactly what the plans that you have talked about to limit household bill increases to less than inflation mean.
Historically, utilities across the United Kingdom have referenced inflation using the retail prices index. One dimension that came from our customer engagement, particularly the customer forum, was a recognition that, for customers, it is no longer the RPI that is recognised, because things such as benefits and the state pension are now linked to the consumer prices index. Our commitment on prices relates to below-inflation increases relative to the CPI, which is a first in the utilities sector. If we looked at the issue in the traditional utility way—relative to the RPI—the price increase in our draft plan would be about 6 per cent below the RPI across the six-year period, whereas it is just a little below the CPI.
On the affordability of the plan, we have tried to work on an iterative basis. We have tried to understand what matters to customers on service and price, and we have looked at the likely borrowing that will be available from the Scottish Government. We have tried to come up with what we believe is an optimum package and to find the optimum point between expectation for service improvement and what customers say that they are prepared to pay. The plan is in draft form, and we will discuss it with the customer forum. Ultimately, we might come out with a slightly different answer.
My understanding is that the draft business plan requires £720 million of new borrowing from the Scottish Government. You have mentioned the importance of that borrowing. How does that compare with the current control period, and what discussions have you had with the Scottish Government on the subject?
In the current period, which is a five-year period compared with six years for the new period, we started with an expectation that we would require £700 million of borrowing. Due to a combination of three factors, that has now reduced to, I think, £485 million. First, there have been beneficial factors in the broader economic environment, such as reduced construction prices. Secondly, there is our performance improvement beyond the targets that were set in the regulatory determination. Finally, because of the practical phasing of delivering our big improvement programme in Glasgow, it will tail into 2017, which means that some of the resources for that will be required in the 2015 to 2021 period.
Broadly, in the current period, the average is about £100 million per annum. In the next period, that figure will rise slightly to £120 million per annum. We had discussions at official level with the Scottish Government, which agreed that that is a reasonable planning assumption to use, and I think that that was reflected in the draft budget that was published back in September.
I seem to recall that, in a previous budget, the Scottish Government took back from you money that you did not need. What happened there?
The borrowing allocation was reduced on a number of occasions over the period. That has taken us from the £700 million that we started off with to the current £485 million borrowing amount. That decrease is a function of the three factors that I mentioned in answer to the previous question.
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Okay. That is fine. The review of charges will have implications for the charges that are levied by Business Stream. How has it engaged in the review and how is it planning to deal with the eventual outcome?
We do a lot of on-going research with our customers to understand their views and attitudes. We analyse customer contacts to look for any areas where they are having problems or in which they want investment, and we feed that into the process. In addition, one of my board members sits on the customer forum and he not only feeds into the plan but consults and challenges Scottish Water on the needs of business customers.
Like you, I am interested to see the outcome of separation and the impact that it will have on business customers, but we have been actively engaged throughout.
We have been seeking to understand the views of all licence providers. From our perspective as a wholesaler, the 12 intermediate licence providers are important customers. Business Stream is one of those providers, but the other 11 are important, too. It is also important to understand the views of the ultimate end customers or users of the products that we supply.
The customer forum is made up of members who are there to act on behalf of householders’ interests, but in addition two members act on behalf of licence providers—Mark Powles mentioned the member from Business Stream, and another major licence provider is also represented. They make sure that the voice of business is heard as well as that of householders.
How do you intend to take the long-term strategy forward? How will you monitor and review the implementation of your long-term plans?
As a business, it is fundamental that we make investment decisions for the long term. Publishing a 25-year strategic projection is a major step forward to make sure that, as far as one ever can, we have the best possible understanding of the longer-term context and the opportunities and challenges over that time horizon so that, when we are making nearer-term investment decisions—typically on pipes and assets that might last for 20, 50 or 100 years—they are rooted in the best possible understanding of that longer-term context. That is why we did the 25-year plan.
It will be important that we keep our forward scanning up to date so that when, for example, we come to our investment review in 2018 and particularly the price review in 2021, we take a fresh update to the strategic projections and roll those forward for 20, 30, or 40 years beyond 2020. There are so many uncertainties and opportunities over that time horizon. The only certainty is that a lot of our assumptions will be wrong. However, that thought process gives us the best possible chance to have a really good understanding of the future and improve the chance of making the best possible investment decisions for the long term.
Do you have anything to add, Ronnie?
I will add one thing. England and Wales will go through the same process at the same time. In the past, some of the providers have had inflation-plus plans. We get good constructive feedback from the people we talk to about what we have put in, such as the regulator and Peter Peacock’s team. They do not just give us a view on what they want; they also give us a firm view on what they do not want.
You may have seen recently that the biggest company in England tried to increase its prices so that it could build a big tunnel, but it was told that it could not have that. I think that it will go into an inflation-minus set-up as well, which will be different from before. Another aspect is the public mood, as it is clear that utility bills are a big part of people’s spend. We do not see whether those companies have detailed plans, but we are keeping an eye on what they are doing, and that is where they are.
Taking a step back from all the work that is being done, I am comfortable that we are in the right place. No doubt there are several months of debate and negotiations to come, but we should not be out of kilter with what they might be encouraged to do—I was going to say “forced into doing”—down there.
That is helpful. The committee plans to hear the views of the customer forum, WICS and other stakeholders in the spring, once they have made known their views on your business plan. We will find an optimum time to do that, but it will certainly be before ministers move to make their final decision.
You will know that the Procurement Reform (Scotland) Bill is before us. Scottish Water, in common with other utilities, is subject to a different procurement regime under the European utilities directive and corresponding Scottish regulations. Can you explain why utilities come under a separate regime?
We have in recent times won a UK award for excellence in our procurement, and we have tried to help with the formation of thinking in that regard. We have what we have. I ask my colleague to give a bit more detail on that.
On the question why utilities have a different regulation regime, the arrangement was clearly born out of measures to ensure that the procurement activities of utilities are regulated right across Europe. For as long as Scottish Water has existed, we have had to comply with all those obligations as set out in the legislation that you mentioned, convener.
Beyond that, we have endeavoured to adapt our whole approach to procurement to ensure that it best meets the needs of our customers throughout Scotland, and that it supports cost-effective and efficient delivery of our services in a way that also supports the local contractor base in various parts of the country.
Specifically, how has it emerged over time that utilities fall under a different procurement regime from other areas?
Additional obligations are placed on utilities. I am not personally familiar with the history of that arrangement in an EU context, but I would imagine that it is about ensuring that, because utilities are there to serve the customers and the broader public through particular activities, the public interest is kept in mind.
We have had representations to suggest that Scottish Water should be covered by the Procurement Reform (Scotland) Bill. One of the reasons is that it is publicly owned. What is your take on that?
That would clearly be an option but, from what I understand of the Scottish Government’s thinking in preparing the bill, it recognises that, because we are already covered by a statutory framework and procurement obligation, there would be an inherent danger or risk of conflict—often at quite a detailed level—if two distinct pieces of legislation applied to us.
As you know, the bill places a number of duties on contracting authorities, which include compliance with a duty of sustainable procurement, imposing community benefit requirements on certain contracts and producing annual procurement strategies and reports. Is Scottish Water already doing some of those things? Is there any reason why you should not do more of them?
Without looking at a checklist of every dimension, I can say in broad terms that we are doing those things. We continually look to evolve our procurement. As Ronnie Mercer said, we have been recognised as having a world-class approach to procurement. We have been awarded gold certification by the Chartered Institute of Purchasing and Supply and I understand that we are the first organisation in Scotland to have achieved that standard.
However, as with everything else to do with Scottish Water, we will never rest on our laurels and we will continue to look at how we evolve our approach. For example, we have done a lot of work to ensure that our approach to procurement supports the youth employment agenda. More than 100 apprentices are now employed in our supply chain. We also look at how we support the local contractor base. We are increasing the use of local framework contractors in more rural areas, because that is the right thing to do to support sustainable local communities and efficient service delivery.
That point is interesting. We have heard—I do not know whether this is anecdotal—of contractors in the central belt getting contracts that cover Dumfries and Galloway and the Highlands and of people running up and down the country in white vans because they have forgotten the right bit of equipment. What you say about using local contractors is interesting. Will you confirm that that is the case? I think that a recent round of contract awarding has made things a bit more centralised.
We can look at what has happened over the years. I can look back at times when things became centralised and we awarded a lot of national contracts. That delivered a lot of efficiencies, but we also found that it created the situation that you highlight, in which a vehicle might go from the central belt for a fairly small job and more time might be spent on travelling than on fixing the issue.
That is not sustainable.
Absolutely. As is consistent with our theme of learning and evolving, we have and will continue to put in place more rural frameworks. I will give some specifics. We now have framework agreements in the islands, as well as the north and Argyll. We are looking to roll out that approach into the Borders and the north-east. The position is continually evolving. We absolutely recognise the point that you made.
We congratulate you on the procurement awards that you have won. What lessons have you learned from your procurement activity that might be valuable for the rest of the Scottish public sector and which we could recommend in the bill?
I will let the experts give the detail, but I will explain part of the reason for Scottish Water’s success. There are another 10 big water and sewerage companies in the UK—nine are in England and one is in Wales. We have used them as comparators to drive costs down and service up. That is all measured by the overall performance assessment, which we have talked about, and by what the bill is.
Procurement is not very different. We drive cost per metre and cost in what we do in laying pipes and building infrastructure against what others in the industry are doing, which is a good comparator for us. If you asked me to choose, I would choose to stay in the utility comparator bit, because we are comparing our procurement not with the rest of the public sector but with Thames Water, Wessex Water, Northumbrian Water and so on. I prefer that, because I know what that is about. I can ask, “How come they are doing that for less than us?” or whatever.
However, there is no reason why we should not do most of the common activities that you mentioned—there is no doubt about that. Joe Rowan was asked to speak to the Government about what we do on procurement because of the award that we won. We tend to share heavily what we think that we are doing well.
We have done that over the years. One example is from our approach to energy purchasing. Energy is one of our biggest costs—we spend more than £40 million a year on purchasing electricity. The approach that we have taken to that for a number of years has been shared with the Scottish Government and I understand that it is now used broadly across the Government.
A lot of the procurement principles are no different from anything else in business—they involve listening to and engaging with the supply chain, working out how we can best align what we need with what suppliers need to drive out value and giving suppliers predictable demand, so that they know exactly what to plan for and can have resources at the right levels for delivering efficiently. That is about planning and prediction as much as anything.
No one has any final questions. That has been a fair session, gentlemen. Thank you for your time. The session has been most useful for us in a variety of areas.
I suspend the meeting to allow the witnesses to leave the room.
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Meeting suspended.
12:02
On resuming—