The Head of Comparative Efficiency at Ofwat has written to the Regulatory Directors of the water companies to set out in greater detail Ofwat’s policy for the 2009 periodic review and the information requirements for the PR09 business plans the companies will have to submit for the next investment cycle. The cost base information required by Ofwat forms a key part of setting efficiency assumptions – Ofwat has used the cost base at each price review to assess relative efficiency in the delivery of capital programmes.

Ofwat is seeking the water companies’ views on a number of issues, including whether the reduced selection of standard costs represent companies’ “bread and butter / material capital programme activity” and asking whether the companies will be able to provide good estimates of the new standard costs developed for maintenance of above ground assets.

Ofwat will undertake wider consultation on the PR09 approach to be issued in October and subsequently the information requirements for draft business plans. This will be influenced by the Report published by Ofwat in July of work undertaken by  Faithful and Gould to research into, and if feasible, develop a methodology / methodologies using best practice capital cost estimating to assess the robustness of capital cost estimates by the water companies. Faithful and Gould recommended that in the short term i.e. for PR09 that the balanced scorecard approach should be adopted and the companies should be instructed to provide these for their programmes of work and individual projects included within their business plans for PR09.

The research addressed a number of Ofwat’s concerns about the business planning process, including Ofwat’s need to reveal uncertainty in business plan estimates to get best value for customers and  to understand if a common level of costing rigour has been applied to ensure their challenges are fair. Other issues included the fact that future costs may become more uncertain (new technology to address climate  change / Water Framework Directive (WFD) etc) and Ofwat’s aspiration of a “Hands-off” Regulatory Process.

The Report by Faithful and Gould also made longer-term recommendations, including that in the medium term for PR14 ( i.e. by 2012) companies should also consider forming a ‘benchmarking club’ so that over time, the performance and trends can be used by them as ‘norms’ for future projects to increase the level of confidence i.e. predictability in the delivery of the project and programme of works and across the water and sewerage industry as a whole.  Faithful and Gould also recommended that the water companies should consider adopting a European Foundation Quality Management (EFQM) approach i.e. Excellence Model, for their whole business to continually improve how they perform and to be able to demonstrate this through a known methodology. In the long term - for PR19 (i.e. 2017) – the Report  recommends that  the companies should consider adopting a common methodology for producing whole life cost plans i.e. life time plans for their assets and then map this methodology into the Regulatory Process.

Following PR04 Ofwat received extensive feedback about the cost base process.  One of the key issues identified was that

“ All companies have consistently outperformed the final determination assumptions, and therefore the efficiency targets must have been insufficiently challenging and the cost estimates in the business plans were not sufficiently detailed or accurate.”  Ofwat’s response said

“We believe there is still scope for efficiency and we intend to continue to use cost base as our tool for deriving part of the efficiency challenge. “

Ofwat will be commissioning a new study of the scope for efficiency, with input from the industry.