Productivity in the water industry

Hello, and welcome to my new blog. I’ll be posting my thoughts from time to time on issues affecting the water industry, and I hope you find them stimulating.

Listening last week to the Budget, I was struck by the gloomy story on the productivity of the British economy.

The latest OBR figures show how the steady growth in national productivity over 35 years went into reverse in 2008, pretty much flatlined since then, and is projected to rise towards an anaemic medium-term average of 1.2% a year.

Productivity growth obviously matters to our national economy. Without it, we will neither restore real terms growth in people’s incomes nor afford vital public services in future. And it matters in the water sector, since it determines both the level of bills people pay and the quality of services they receive.

Those are some of the reasons why we recently commissioned respected consultants Frontier Economics, working with Professor David Saal of Loughborough University, to assess what has happened to water sector productivity in England since privatisation.

We’re publishing Frontier’s report today. I think it makes fascinating reading, particularly given recent criticism of the sector by some and the Labour Party leadership’s pledge to nationalise companies in England.

It shows that between 1994 and 2017, water and sewerage company productivity in England grew annually by an average of 2.1%, making the sector 64% more productive now than it was then, based on some relatively cautious assumptions on the improvements in the quality of the service provided.

The figures reflect improvement in both the productivity with which companies operate and the quality of what they deliver. Put crudely, it is not just about providing the same water and sewerage services as in 1994, by using fewer employees and smarter kit. That is certainly part of the story, but it is also that the quality of the services provided is itself better.

What the report also shows is that, productivity grew strongly in the years immediately after privatisation, followed by a period of intermediate growth and latterly a period of significantly lower (sometimes even negative) growth.So what does this all tell us? Well, in the period overall and taking account of improved service quality, the sector outpaced both the economy as a whole and a basket of comparator sectors.

Even if one were to take an uber-cautious view by taking quality improvements in the water sector out of the equation, the analysis suggests that over the period water still did better than the economy as a whole and broadly matched the comparator group of sectors.

The combined contribution to sector productivity of quality improvements and operational cost reductions will come as little surprise to any well-informed observer of the water sector.
On the one hand, companies over the years have delivered increasingly world-class water quality, cleaner beaches and higher levels of customer satisfaction, made possible in large measure by £150billion of investment.

And on the other hand, as Ofwat would probably put it, these things have been achieved by private sector companies within a framework of robust, independent regulation which has ensured that bills are £120 lower than they would have been if the combination of privatisation and tough independent regulation hadn’t happened.

The trend of productivity growth will also come as little surprise to people who study these things, as the low hanging fruit on cost reduction gets plucked early and the job of continuous improvement gets harder. It also chimes with the trend in customers’ bill reductions due to Ofwat’s efficiency challenge, as observed by the NAO in 2015.

But the obvious sting in the tail is the scale of the productivity challenge ahead for our sector if we are to continue delivering better, more resilient services while keeping bills affordable. There needs to be a turnaround in the rate of productivity growth of the last decade identified in the report, even if the figures are to some degree underplayed thanks to conservative assumptions about more recent improvements in service quality.

That’s why it’s important to get the current price review right. It’s the reason why, in seeking to promote both resilience and affordability, Ofwat and companies alike place so much emphasis on at least two things: finding the sweet spot between stretch and realism on targets and incentives; and on stimulating much greater innovation within our sector.

One water sector chief recently hinted to me that their company may need to find double-digit efficiencies in the control period to 2025. Each company’s figures will, of course, be different. But if even just half that were replicated across the sector, it would compare impressively with official forecasts for productivity growth in the economy as a whole - and would be a strong sign of the positive commitment which water companies are making to our country’s future.