Privatised utility

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A modest proposal for the founding of the “customer corporation” in utility industries.

Britain’s privatised utilities are unloved. The last few months have seen a row over Cedric Brown’s salary, the reopening of the electricity price review, and a squabble over the payment of a special dividend to directors of the National Grid. The long hot summer has not been an enjoyable one for water companies.

Perhaps it has just been a bad year. Or are these the symptoms of a more fundamental problem?

Privatised natural monopolies in Britain have not acquired what sociologists and political philosophers term legitimacy. Legitimacy is a good answer to the question “what gives them the right to do that?”. It is a subjective concept, because the answer has to appear good to the person who asks the question, not just the person who answered. And when the question is posed for a private company delivery a monopoly public service, most people don’t think the answer is good enough. It is because of this lack of legitimacy that privatisation remains unpopular even as it has started to deliver demonstrable benefits to consumers. It is why there are no supporters of rail privatisation. And it is why attempts to bring market forces and managerial autonomy into the health and education services are running to the sand.

As Francis Fukuyama puts it in the End of History, “legitimate government enjoys reserves of goodwill which protects it when things go badly”. This summer, water companies discovered that their reserves of goodwill were even lower than their reserves of water.

The drought of 1976 was an occasion for good-humoured solidarity. The drought of 1995 was blamed on Yorkshire Water.

The legitimacy problem arises from a floatation process that was directed more to the capital market than to the needs of customers. Since the government’s main concern was to sell the companies, it is easy to see why this happened. But it has proved a mistake. Customers are more numerous than investors and more politically powerful. They are starting to take their revenge.

Consumers can vote for or against Tesco with their feet, and success in product market competition is the most effective method of legitimising corporate authority. But no national monopoly acquires legitimacy in this way. Perhaps a different governance structure is appropriate. There has been a failure of imagination in supposing that the only alternative to our discredited form of nationalisation is the plc. One alternative I have proposed in a lecture to the Institute of Economic Affairs on 31st October is a corporation whose principal obligation is to customers rather than shareholders. A plc will seek to make as much profit as possible but can do so in a competitive product market only if it meets the needs of its customers. One way of dealing with a monopoly is to reverse these priorities. The primary objective of a customer corporation is to satisfy its customers, and it can do so in a competitive capital market, only if it meets the needs of its shareholders. The obligation and responsibilities of the board are to customers rather than shareholders. The success of the company (and the prestige and remuneration of its managers) would be measured, not by profits, but its ability to reduce the prices its customers pay.

In reality, customer priority is the natural instinct of the vast majority of managers of these companies. Few of them jump out of bed in the morning looking forward to the prospect of another day spent enhancing shareholder value: most of them genuinely relish the notion of doing a good job for their customers. By telling managers that their objective is to maximise profits and that it is the regulator’s job to represent the consumer interest, we create an artificial tension which serves no purpose and which leaves everyone dissatisfied.

Managers resent regulatory intrusion in their business, consumers believe their interests are inadequately represented, and both are right. Customer focused corporations are the appropriate mechanism, not just for national monopoly utilities, but also for activities such as the BBC, health and education, which need to be freed from the dead hand of direct state control.

In advocating customer corporations, I definitely do not envisage that consumers would own the corporation or elect directors to its board. The interests of customers are better served by professional managers devoted to these interests than by avowed consumer representatives. Such people are in the main demonstrated to be unrepresentative by their very willingness to undertake the job and the co-operative movement failed because consumers in fact left the management of the business to local politicians Effective boards are focused on business issues and display an identity of interest and purpose. The present method of choosing the boards of plc’s – which are effectively self-perpetuating, with a theoretical safety-valve provided by an annual process of shareholder election – is hardly ideal. But it works well enough in practice and there is no reason why the boards of customer corporations should not be chosen in similar ways.

But who would invest in a customer corporation, and on what basis? The simplest form of finance would be indexed preferred stock, carrying a fixed dividend linked to the RPI. Priced on a basis comparable to the similar permanent interest bearing shares issued by building societies, these might require a real yield of between 5% and 6%. This is below the 6% to 7% real yield, allowed to utilities in the recent regulatory reviews. The reduction in regulatory risk, and the sharing of some business risks with users, means that customer corporations would actually be able to finance their operations more cheaply than companies whose first priority was their shareholders.

Some utility executives will see in this proposal an erosion of the freedom to manage which privatisation has given them, and which is indeed one of its great achievements. The intention and effect are just the opposite. It is to give back the managers the freedom to make decisions about levels of service and necessary investment which they are best placed to make, and which the current regulatory structure has taken away from them. But only a revised governance framework can make that freedom possible.

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