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Comment Chief executive's view Dr Jerry Bryan, Albion Water Cherry picking The real benefits of upstream competition come not from targeting the lowest cost-to-serve customers but the highest. Incumbents should harness upstream competition to reduce these imbalances. E stablished utilities often go to great lengths to protect the status quo when faced with market reform. One effective defence mechanism has been to raise fears of serious unintended consequences but, powerful though it undoubtedly is to remind a minister that a typhoid outbreak would not be good for his political career, the reality is that many of these fears are unwarranted and potentially self-defeating. Incumbents have lobbied hard against the potential ill effects of upstream water competition, arguing in particular that this would lead to entrants "cherry picking" those customers who are cheapest to serve. This, the argument goes, will inevitably lead to the de-averaging of tariff structures, to the significant detriment of those who are most costly to serve, notably the rural poor. That cry has been taken up by a number of industry stakeholders, notably the Consumer Council for Water, which has spoken out against cherry picking. I speak as someone who has been intimately involved in promoting water competition for almost two decades and who has often been challenged by the cherry picking accusation. Sharing a Utility Week conference platform with a Severn Trent director over a decade ago, I was accused of cherry picking and challenged instead to take on Severn Trent's high-cost customers in Shropshire. I readily agreed to do so but the offer was withdrawn as rapidly as it had been made. Looking at this from a commercial point of view, I can find no evidence to support the perceived risk of cherry picking and no commercial logic to drive such behaviour on the part of entrants. Let's look at the facts. There is no doubt that some customers are far more expensive to serve than the average and, logically, some will be significantly cheaper to serve. It would technically be possible for an entrant to target those cheapest to serve, but only if it could obtain some form of locally cost-reflective wholesale terms from the incumbent. There are no realistic prospects of that occurring and Ofwat has set its face against any such approach. For those aware of Albion Water's decade-long battle for 6 | 8th - 14th November 2013 | UTILITY WEEK fairer prices for Shotton Paper, this was not a it is a process that turns potentially valucase of de-averaging but rather a challenge to able organic material into carbon dioxide a discrete non-potable tariff. In that case the by expending a lot of energy. The industry courts found that the applicable costs, which should have moved on long ago to treatment were used to justify that tariff, had been sig- processes that recover value from sewage nificantly and abusively overstated. with minimal carbon footprint, but progress I would argue that the natural target for has been glacial. any innovative entrant is not the lowest If technological change is difficult, then cost-to-serve but the highest. Information fundamental service innovation must be from Scotland suggests that 1 per cent of the more so. The concept of continuous suppopulation served make up some 16 per cent plies of wholesome drinking water and the of the total opex and that some customers discharge of all wastewater to sewerage sysare 30 times more expensive to serve than tems has been with us since late Victorian the average. For these customers, times. These Victorian service defiinnovation has the potential to nitions still drive the water industry drive down those costs to the bendespite growing concern that we efit of the incumbent, the generalare flushing toilets and watering ity of customers who are currently gardens with drinking water, while cross-subsidising high-cost serrainwater and greywater often go vices and, of course, the entrant to waste or contribute to the floodthat is taking a commercial risk ing of overloaded combined sewer and seeks reward. systems. Water companies' ability to Instead of perpetuating an reinvent water services is very often irrational fear of cherry picking, Most constrained by legacy systems and incumbents should be following incumbents conservative attitudes. the Scottish example and identiIt needn't be so. If incumbents appear to fying their highest cost-to-serve cannot satisfactorily drive down customers. Prior to 2009, many find it very the cost of their most expensive incumbents appear to have had difficult to customers then perhaps we need little knowledge of these detailed accept the to see open competition as a potencosts, but since Ofwat introduced tially valuable tool to achieve that risk that the requirement for accounting end. Incumbents could identify the separation there is no excuse for significant characteristics of such customers innovation not knowing who to target. and the key cost drivers and invite Incumbents or their exist- entails innovative solutions from entrants ing supply chains are capable of and others. Success would benefit driving down these costs, and they should incumbents, customers generally and the be doing so vigorously. Where this requires innovators. Those innovators would also technological or service innovation, that be expected to shoulder some or all of the may not be easy. Most incumbents appear costs of failure, but even failure would assist highly conservative and find it very difficult our understanding of what was needed. We to accept the risk that significant innova- could start with the most costly 1 per cent tion entails. The water industry's attitude – a modest and low-risk proposition and towards technological innovation may best somewhat easier to agree than the whole of be illustrated by the plans to celebrate the Shropshire. With apologies to the Romans, it centenary of the introduction of the activated was the UK that invented modern water and sludge process for treating sewage. It was wastewater systems in the 19th century. Perintroduced in 1914 and is still responsible haps we could harness our innovative potenfor treating the vast majority of sewage both tial to make those systems lower cost and in the UK and in urban areas worldwide. Yet sustainable in the 21st.