Threads - 9 December 2008

First of all, we at Indepen would like to take this opportunity to wish you the very best for the festive season. May you have a very happy, healthy and prosperous year in 2009 and may your business, in whatever sector, successfully weather the current storms.

In this issue of Threads, we take a look at the exchange of views at some of the recent events we have held and highlight background work we have been doing on incentives and penalties in regulated industries. Then we preview some topics we have in store for CHEFs and roundtable events during the coming year.

‘Infrastructure and the City’, 28 October

At our recent CHEFs event, we tackled the topic of infrastructure in our capital city – a very broad and complex subject and, in the current financial situation, fraught with imponderables when it comes to funding.

The primary focus of the evening was transport. Michael Roberts, Chief Executive of the Association of Train Operating Companies, talked from the point of view of the rail industry. During the morning rush hour, half a million rail commuters enter or leave Central London. About 70% of national rail journeys start or finish there and Waterloo alone sees almost a third more passengers than Heathrow. In London and the South East, the number of passengers has grown by 45% over the last decade.

London’s performance, in terms of service, is slightly better than the average and regulated fares are 1.6% lower in real terms than in the final days of British Rail. But when it comes to passenger perception, the picture is not so rosy. For value for money, the London/South East region is rated lower than anywhere else in the country. The real crunch issue is capacity: there is a close correlation between the perception of value and the availability of a seat. Timetables have already been cleverly tweaked, so the options for capacity improvement are longer trains and platforms and new, physical infrastructure work. Five new lines, including CrossRail, are proposed and 800 new vehicles are due in the region.

There are some big challenges, not least of which is the potential impact of the changing economy on train operators and policy makers. There are major tasks in delivering the new projects and managing the creative tension between a number of players – the Mayor’s Office, the GLA, Transport for London, Network Rail and the Department for Transport. And when it comes to fares and ticketing, there is a balancing act between raising revenue, managing demand and delivering value for money, as the passengers would see it.

Steve Norris, Board member of both the London Development Agency and Transport for London, felt that the big issue for Londoners was the need to feel safe in their homes and in the street. Fear of crime may only be a perception but it needs to be addressed. Second to that comes the need to get people to work as efficiently as possible. Here, the UK, alone in Europe, expects public transport to be paid for by the user. But there are non-user benefits (less congestion, cleaner air) when more people use it. There are a number of improvements in the pipeline, including tube upgrades, CrossRail and the East London line. And the Mayor’s ‘Direction of Travel’ document proposes changes to the bus system, improvements for cyclists and pedestrians, and re-consideration of the private car. Further issues for London are skills (including engineering for the rail sector), housing (and a likely demand for rental accommodation for people not wishing to get on a precarious housing ladder), air quality and energy supply.

The discussion chaired by John Dickie, Director of Policy and Strategy for London First, considered whether high speed rail or teleworking might be solutions and whether there should be a vision that ‘rises above populism’. There was some debate about the Olympics: the budget, whether private funding would come through and what the legacy will actually be. What will happen once the Games are over?

Continuing the Infrastructure discussion......

Some strong themes came through from the speakers and Indepen is considering a return to them in future CHEFs discussions.

  1. Hard versus soft infrastructure. Infrastructure is not just a matter of hard steel and concrete – it’s not just about assets. There are some softer issues around social elements as well, including the need for skills and for consideration of the community using the infrastructure. Are these the most important elements? What others might there be and how should they be addressed?
  2. Customer focus: perception and reality. Both our speakers gave examples of the importance of perceptions: Londoners’ view of crime in the city and passengers’ view of value for money. In both cases, the perception differs from the reality. What does this mean for companies and their strategies? How do we understand what people think so we don’t misinterpret, as has happened with ID cards?
  3. London and the rest of the country. There is a long-established ‘pull’ towards the South East of the country and towards the capital. People and money tend to gravitate towards it. But investment in infrastructure, such as transport, outside the South East could help to make other cities and regions more attractive. And if you are teleworking, it doesn’t really matter where you live. Could and should the ‘pull’ be reversed? How might this be achieved?
  4. Funding and politics. The topic of transport brought up the question of who pays for it – the passenger or the state. The question also came up in the discussion of the Olympics and funding for the regeneration aspects of the project. Who pays for infrastructure and who benefits? Is the balance in the right place?

We are keen to learn which of these topics would be of interest to you, so do give us your thoughts. Please see the last page of Threads for contact details.

‘Promoting innovation in regulated industries: pushing water uphill?’ 13 November

Professor Martin Cave of Warwick Business School opened the discussion at our recent round table on innovation. He spoke with reference to the interim report of his Review into competition and innovation in water markets. Rather less than half the report was devoted to innovation, not through design but through a lack of information and benchmarking data. Duncan Thomas’ work at the Manchester Institute of Innovation Research had confirmed the lack of evidence about innovation in the water sector. There was not even a shared understanding of what was meant by innovation.

It was reasonable to suppose that where activities were amenable to competition, concerns about innovation would fall away. So he had focused on those parts of the water industry that were not competitive or easily competitive. His interim conclusion is that certain features of the current régime are antithetical to innovation. He pointed to the prescriptive nature of environmental regulation (and the need for more flexibility and a greater concern with outcomes) and the lack of economic incentives to innovate. The contrast between the large returns to management achieved through financial as opposed to operational innovation was a point noted by others.

Water is different from energy, which has been living with a liberalised supply market for some 15 years, albeit at the cost of greater exposure to world markets. Innovation in energy supply has led to new service offerings to consumers, while in price-regulated parts of the sector the incentive to innovate is shaped by the form of the price control. So far as capex is concerned, the incentive tends to be to ‘make do with less’.

The discussion centred around four major themes:

  1. Who should innovate? While traditional utility R&D spend has fallen, this does not mean nothing is happening – there is greater use of consultants and partnerships. Is it for utilities to be ‘first adopters’ of (risky) new technology or should they be second or third? Is it preferable for them to innovate or to be the best buyer of newer, smarter and competitive solutions developed by others?
  2. Incentives to innovate. Under price regulation, the concerns tend to be with outputs and the economics, with efficiency rather than innovation, with incremental rather than radical change. What does this mean for prices and customers? What is the impact of putting in ‘dumb’ assets when the regulator would not approve investment in smart assets now for benefits in the future?
  3. Future challenges. In the long run, there is risk of carrying on with ‘business as usual’ and seeing innovation as ‘someone else’s responsibility’. How would the current regulatory incentives cope with paradigm shifts that might be brought about, for example, by climate change? How could we incentivise responsiveness and creativity? Is one answer to provide equality of treatment of capex and opex? How can utilities be incentivised to provide something that customers would value?
  4. Organisational barriers. It is not just the regulatory framework that is important in addressing the issue but the way in which it operates. New entrants have been surprised by the positive response they received from most of the players, but some barriers still exist in terms of both organisations and policy. How can the regulators and the regulated work together to the long-term benefit of consumers?

Incentives, enforcement and penalties.

Indepen has been carrying out some background work on how regulators are making use of the carrots and the sticks that they have at their disposal. In 2002, introducing the parliamentary debate on penalties in the energy sector, the Minister for Industry and Energy announced ‘we aim to have good standards of compliance, not lots of fines’. So is this actually happening? Do we have the policy framework, the regulatory processes and the relationships that are likely to deliver such a result?

Regulated industries support the rationale behind incentives packages (which contain the price control and the licence). They safeguard the consumers of essential public services. But while price controls provide efficiency incentives, they are thought to be less effective in ensuring compliance with service and quality standards – and this is where enforcement and financial penalties have a role to play. As regulatory régimes are tweaked over time and become more complex, it is not clear that the right balance between reward and punishment is achieved. There is a view that penalties have been ratcheted up while incentives are being eroded: the stick is getting bigger.

There is also a view that there is room for improvement in penalties régimes and the process of enforcement, particularly in terms of the various roles undertaken by the regulator. There appears to be inconsistency in the application and size of penalties between the different regulators. In addition, compared with penalties from economic regulators, health and safety fines appear low and environmental fines very low. Nevertheless, penalties are thought to have improved regulators’ weaponry when it comes to ensuring compliance, though it is not clear how the psychology works. The pressure may come from the financial threat, or it may come from the potential risk to a company’s reputation. What’s more, the effect may vary depending on company ownership, structure and culture – and the way the media treat individual cases, homing in on some more than others.

The exploratory work so far suggests that more needs to be done on these issues and we expect to return to them. If you have experiences of the penalties régime that you would be willing to add to our growing set of examples, we would be very pleased to hear from you.

What’s in store for 2009?

We have already mentioned that we may take forward some of the themes that came out of our CHEFs event on Infrastructure and the City. Other topics in the pipeline include:

Your thoughts

If you would like to give your views on which of the proposed topics for 2009 would interest you, or comment on any of the themes introduced in Threads, do contact Ann Bishop.

Archived Threads 2008