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10 | 27TH NOVEMBER - 3RD DECEMBER 2015 | UTILITY WEEK Policy & Regulation Analysis T his summer, Utility Week and global design and consultancy firm Arcadis conducted research with operations leaders in the UK water sector to try and understand their interpretation of the innovation chal- lenges facing the sector and to what extent they see the move to totex as being linked with these challenges. The resulting findings were recently published in a report, which can be downloaded at utilityweek.co.uk. The following pages provide a summary of the key mes- sages and insights in that document. Context The UK water sector is experiencing a time of signifi- cant change. The recent PR14 price review took a radical departure from previous iterations with an overt focus on risk and reward. Meanwhile, measures to improve cus- tomer centricity in the water sector – such as the Service Incentive Mechanism (SIM) – are evolving, new require- ments for long-term resilience are being designed and provisions are being made for the liberalisation of the non-domestic retail market in 2017. With these wide-ranging changes to the economic regulatory structures that underpin day-to-day opera- tions in the UK water sector, the case for innovation is becoming urgent. But innovation is not easy. Leaders in water companies are aware that new per- formance measurements and expectations will require new thinking and ways of working. At the same time they also know that they cannot leap forward with changes that might risk continuity or quality of supply, or which might unsettle shareholders. This conflict between pres- sure to change on a number of fronts and the need to maintain the utmost levels of confidence from customers and the wider stakeholder community are a potentially paralysing combination for innovation. Against this backdrop, Utility Week and Arcadis con- ducted research with operations leaders in the UK water sector to gauge sentiment about innovation challenges. In particular, we sought to understand perceptions of totex – a fundamental feature of the new style economic regulation introduced during PR14 – and its impact on innovation in water company operations. Summary Our findings can be broken down into two main areas. First, those which are relevant to water sector innova- tion challenges generally, and second, those which express opinion about the relationship between totex and innovation. Broadly speaking, we found that operations leaders in the UK water sector have a high regard for innova- tion and see it to be important to their job roles. How- ever, there is a suggestion of a stagnant or complacent approach to innovation challenges since, despite con- siderable changes afoot in their regulatory environment, these individuals do not see the importance of innova- tion to their job roles increasing over the current AMP cycle. Furthermore, our respondents do not see totex as being an important driver for innovation. Other drivers, such as rising expectations around customer engage- ment and new penalties for failing to respond to outcome delivery incentives, are seen as having a bigger influence over innovation activity. Cost-cutting or efficiency ini- tiatives more generally are also seen as key drivers. But again the need for efficiency is not directly associated with totex, either as a driver or enabler. While this is understandable given the focus placed on customer engagement in recent years – via the intro- duction of SIM, customer challenges groups, and so on – failure to recognise totex as a driver for innovation may result in significant opportunities for efficiency and regu- latory outperformance going unrealised. Experts commenting on these findings observed that the process of adapting to totex in the water sector may be a long one. Recently, Ofwat chief executive Cath- ryn Ross welcomed the progress water companies have made, but she also made it clear that there is a lot more scope for improvement. The faster water companies can realise this, the faster they can enjoy the associated efficiency and performance benefits. However, as some commentators pointed out, pro- cess barriers – as well as cultural ones – are making it difficult for water companies. They said long-standing taxation mechanisms persist in treating operational and capital expenditure differently, despite Ofwat's introduc- tion of totex. This makes internal accounting and invest- ment decision-making processes difficult to change. According to respondents, the biggest positive influ- ence totex is expected to have is that it will lead to more benchmarking and learning from other sectors in order to support operational excellence in the water sector. However, respondents also admit that currently, benchmarking is weak. Most respondents said it is car- ried out infrequently and without robust frameworks. Therefore, if totex is to lead to benefits for water compa- nies, a step change is needed in the approach the sector takes to absorbing best practice for efficient operations from other sectors – both in the UK and further afield. Innovation and totex Research by Utility Week in association with Arcadis shows operations leaders in the water sector recognise the need to innovate but are reluctant to embrace the change this requires. Barriers to innovation The top three chal- lenges to innovation in operations in the water sector are perceived to be: risk aversion (70%), lack of invest- ment/funding (49%) and regulation (34%) Where lack of investment is a barrier, 83% say it is due to competing priorities for investment The fixed five year AMP cycle complicates investment decision making 30% identify that there is a capability gap in driving innova- tion into operations Other barriers are identified as lack of time and resource as well as failure of culture Download the full report at: utilityweek. co.uk/downloads