Ofwat has launched a new consultation seeking views on how to encourage water companies to deliver more of the outcomes customers want.

The consultation discusses how the water industry regulator can make outcomes better reflect customer preference at the 2019 price review (PR19)- the outcomes framework is one of the key elements of PR19.

According to the regulator, more stretching performance commitments will deliver higher service levels to customers, future customers and the environment – but Ofwat said it was important that these do not just translate into higher bills, adding:

“ This is why we need to consider the balance between financial incentives in the price review and whether a higher proportion of company revenue should be linked to service performance through ODIs, rather than other price review tools. In addition, more powerful ODI rewards are not acceptable unless they represent outperformance beyond truly stretching performance commitments.”

Introducing the consultation, Ofwat said:

“By focusing our regulation on the results or outcomes customers receive, it means water companies set their priorities based on delivering what matters to consumers. This approach, which was introduced in 2014, has been successful but we want to improve it for the next price review in 2019.”

All of the water companies have performance commitments agreed in collaboration with consumers about how they will reach the desired outcomes for customers e.g. on the quality and reliability of water supply, how well water companies look after their local environment and how good their customer service is.

Companies have reputational and financial incentives to deliver their performance commitments known as outcome delivery incentives. Companies report on their performance each year and for some performance commitments have financial rewards and penalties depending on how successful they are in delivering their performance commitments.

Ofwat is consulting on four areas in the consultation launched today,:

• how companies’ performance commitments can be made more stretching to deliver higher service levels to customers
• how outcome delivery incentives can be strengthened to encourage companies to deliver on their performance commitments to customers
• how resilience can be better reflected in outcomes to ensure the interests of future customers are taken into account
• how performance commitments can be made more transparent to make it easier for customers to hold companies to account

Proposals include replacing SIM and setting common performance commitments for all companies

Proposals Ofwat considers will promote stretching performance commitments at PR19 include:

• the better availability of information, including comparative information on company performance, to enable customers and local stakeholders to understand and challenge company’s proposed performance commitments
• the specification of common performance commitments for all companies to enable customers and local stakeholders to better compare performance on the key measures that matter to customers
• setting stretching performance commitments for leakage which is a priority issue for customers
• whether there are important areas companies should cover with their bespoke performance commitments, such as customers in circumstances which might make them vulnerable
• the development of a new customer experience measure to replace the service incentive mechanism (SIM) to drive further improvements in customer service in the sector, including comparisons with other sectors and use of digital service enablers

David Black, senior director at Ofwat, said:

“By focusing on the results customers want, rather than giving companies a prescriptive list of activities, we are putting customer interests at the top of water companies’ thinking and planning. And by getting the right incentives and penalties in place, we keep their minds focused on delivering for customers.

“This approach gives companies the space to innovate, find new solutions and ways of delivering for customers. It has worked well, but we want to hear ideas and thoughts about how we can make it even more successful for customers.”

Ofwat said it is already seeing evidence from the first year of reporting that the outcomes approach is causing some companies to focus more on delivering what matters to their customers, future customers and the environment as well as driving significant improvements in service. The use of rewards and penalties appears to be important in driving better performance relative to an approach based only on penalties, the regulator said, an approach it wants to build on for PR19.

"Some stakeholders have raised concerns that that ODI rewards can lead to higher bills and more powerful ODIs will exacerbate this"

The consultation paper suggests that a purely penalty-based outcomes framework could lead to higher bills, compared to a reward and penalty approach which could also see customers receive a better quality service for a given bill level. 

Commenting on some stakeholders concerns that ODI rewards can lead to higher bills and that more powerful ODIs will exacerbate this, the consultation paper says linking a higher proportion of revenue to ODIs could lead to lower bills than would otherwise be the case, while at the same time providing an incentive for frontiershifting service performance.

“It does this by changing the balance of how companies earn their return towards service delivery and away from other sources of return such as outperforming the cost of capital. Linking a higher proportion of revenue to ODIs should encourage companies to delivery improved service quality within a given bill affordability constraint.”, the paper says.

Resilience - 5 year performance commitments to 2025 must be supported by long-term projections for further 10 years at least 

On resilience, the paper says Ofwat has decided that companies’ five-year performance commitments for 2020-25 should be supported by long-term projections for at least a further ten years, following consultation on the issue in May. The regulator said the projections will help encourage companies to consider their long-term ambitions and will help customers and stakeholders engage on longer-term issues. 

Ofwat also expects that companies’ outcomes will be focussed on the long-term – the paper says:

“ This approach supports our expectation that companies put their five-year business plans in a genuinely long-term context at PR19. We will assess how well companies have done this at the PR19 risk based review by, for example, taking account of the quality of the evidence provided on longer-term planning, the customer engagement on this planning and the alignment between the business plan and longer-term planning.”

Ofwat said it is also open to companies proposing longer-term performance commitments with a default assumption they will remain unchanged beyond five years and longer-term ODIs in relation to some or all of their longer-term performance commitments. This could include direct procurement schemes that go beyond a single price review where appropriate.

The closing date for responses the consultation is 31 January 2017. Click here to download the consultation document.