As published in the September 2021 issue of The Water Report.
Ofwat's recent PR24 consultation signals another new direction for customer engagement in water. Its latest thinking arguably demonstrates the difficulties that it has had with the concept and will be of great interest to other regulators, notably in energy.
Regulators want monopoly businesses to attend to the wants, needs and expectations of their customers. They want customers to be as important to regulated businesses as they are to competitive businesses which live and die by their ability to meet consumer demands. This has been a long-term project over several price reviews and one which is clearly difficult.
Regulators have used various tools to encourage companies to have more regard for their customers. Targeted regulations, such as incentives which link financial outcomes to customer service metrics, sit alongside price control settlements which seek to reflect how well companies engage with customers and how well they reflect the outcomes desired by customers in their plans. These initiatives may have had some influence in turning the culture of regulated companies towards customer service in recent years. Ofwat reported: "We’ve observed a culture change in the sector over the last decade, with an increased company recognition that engaging well with customers and communities is fundamental to delivering services that meet their needs."
Frustrations
But both sides are frustrated. Water (and energy)companies have responded to regulators' expectations and most have devoted substantial resources to customer engagement only to find that, in their view, the insight derived has not been reflected in regulatory determinations. Some reasonably ask, rhetorically, why they should bother in future.
Ofwat, on the other hand, observes outcomes from research which it says are hard to square against one another and against its own expectations. Commenting on PR19 research, for example, the regulator said: "Evidence of customer support for proposals…appeared inconsistent. For example, companies sometimes struggled to provide evidence that customers support outperformance incentives, despite providing evidence that customers were willing to pay for enhancement investment and associated improvements in service."
The view is revealing. For while what companies have reported as the results of their engagement has sometimes been dissimilar, that is not the same as saying the results are inconsistent. There is a potentially coherent message from customers: that they distinguish between a quasi-contract in which certain outcomes are delivered for a known price, and an arrangement which is premised on financial incentives for companies to do the right thing and which carries the risk of companies not achieving it. This points to the need for a deeper appreciation of what customers are saying, rather than dismissing it as 'inconsistent'. It may also imply that regulatory incentives, however effective, are simply not popular –awkward for a regulatory regime in which incentives play such a core role. At the very least, it points to the need to get to grips with the challenge of how to talk to customers about risk.
National level research
Ofwat floats two notable changes in direction in its expectations for customer engagement atPR24. First, it is proposing the idea of collaborative research, the aim of which is to iron out inconsistencies of method between companies to increase the comparability of findings.
There may be some justification in Ofwat's concern about inconsistent methodology, particularly when it comes to the notoriously complex and frequently misunderstood and misused "willingness to pay" studies. But it is not clear that Ofwat is only talking about such studies in promoting collaborative research. This needs clarifying.
What we do know is that Ofwat plans to get involved in "design and implementation" of national level research programmes. This spells danger and looks like something that really ought to be avoided: regulators concerning themselves with the nuts and bolts of managing company business. The initiative carries the risk that the research may end up being consistent but at the expense of it being inappropriate and stifling innovation – the lowest common denominator may prevail.
Ofwat has said such a programme would be complementary to companies' own research, but herein would lie an acid test: how much notice will Ofwat take of what companies do, compared to the outcomes of its own more directly controlled research? It will no doubt (and rightly) expect companies to mount robust cases for why it should not be able to ignore company-driven research and engagement.
Unhelpfully, there is no real consensus on how customer engagement should be factored in to regulatory decision-making. Even the CMA in its recent PR19 appeal judgement succinctly summarised the positions of the various parties without shedding a great deal of light on how such tensions should be resolved.
Collaborative research is an intervention which has the hallmarks of regulation by command and control. Some companies may well be tempted (and relieved) just to do what Ofwat tells them – it is easier – but the danger is that it is ultimately less good for customers. On the other hand, many companies will chafe at the intrusion.
Above all this, however, there is something ironic here about the juxtaposition between Ofwat's recognition that companies have moved towards a more customer-centric culture and its belief that a more intrusive approach is now needed.
Challenging the Challenge Groups
By contrast, the second notable direction is to remove a mandate for Customer Challenge Groups. These groups rose to prominence two price reviews ago and had the worthwhile aim of forcing companies to do better at understanding and acting on what customers wanted. The idea was that a group of independent and well-informed people, knowledgeable about customer needs (including where possible customers themselves), could effectively challenge business plans.
There are different models but in practice Ofwat has been uncomfortable about the outcomes and in particular has been concerned by "capture" - the idea that the independence of such groups is compromised by their closeness to the companies and that they effectively became merely a mouthpiece for the companies' positions.
In my view, that is an unfair reflection of the expert and committed individuals who have contributed to such groups. But it is true to say that there are difficulties in translating a good idea into reality, with the asymmetry of information available to the groups compared to what is known by companies being a key challenge. What has resulted has seemed at times to be a self-fulfilling cycle of distrust. Ofwat's suspicions of lack of independence have led it to under-weight the opinions of the groups, especially where they are supportive of what companies say customers want. This is often seen by the companies and the groups themselves to fit a narrative of Ofwat "ignoring" the groups.
Nonetheless Ofwat's move, whether prompted by such concerns or not, does seem to go in an opposite direction to its collaborative research idea in one respect: it signals a step back from mandating how companies should manage the engagement process, instead requiring companies to come up with assurance and challenge processes which are appropriate to their individual circumstances.
On the face of it, this is a positive thing. What Ofwat is silent about, however, is whether it intends to make any judgement on companies' approaches. A positive view of this is that Ofwat would take note where such groups are shown to be genuinely independent and challenging such that the resulting assurance is valuable. A more cynical view is that the move allows Ofwat more leeway to ignore opinions which are not to its liking.
Companies for their part are very unlikely to ditch the Challenge Group arrangements completely. Forward-thinking companies recognise the value that such arrangements can provide but at the same time must be alert to the temptation to manage the process for their convenience.
Think bigger
What then should companies make of these ideas? My answer is "not too much". They are, after all, about how price reviews are conducted and while that is undeniably important, it is secondary to the more important point that customer needs, views and behaviours are always critical, even for monopolies. The best companies will see customer engagement not primarily as an activity intrinsic to price controls, or even as crucial for legitimacy but as strategically fundamental.
Customers are increasingly active participants in the future of the regulated sectors. Understanding and influencing how they behave will be crucial for achieving good customer and societal outcomes. The big challenges in water and energy – including net zero, sustainable water resources and a clean environment – will only successfully be met if customers play an active part. Virtually everyone recognises this but whether regulated companies have fully embedded customer engagement as a strategic capability is moot. In companies that have, engagement will receive serious attention by those setting the tone at the top – boards, investors and the senior executive – and the approach to customer engagement will be tied to important strategic goals, not just price controls.
Companies should be taking advantage of growing opportunities to engage in innovative and targeted ways. And make sure the resulting outcomes are central to running the business from top to bottom. Too often customer engagement "between" price controls is incoherently planned and not clearly tied to strategic objectives. Customer engagement should be a core business capability, not only part of a price determination programme.
[1] https://www.ofwat.gov.uk/publication/pr24-and-beyond-creating-tomorrow-together/. pp55-65
[2] https://assets.publishing.service.gov.uk/media/60702370e90e076f5589bb8f/Final_Report_---_web_version_-_CMA.pdf pp99-101
