Water companies not built to float

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Water companies are unloved by their customers and by the market. The privatisation settlement was essentially flawed. Kelda’s initial proposals have now been abandoned, but a version of them deserves to succeed.

When the Soviet Union collapsed at the end of the 1980’s, no-one was more delighted than the managers of the only supermarket in a small town in Siberia. The shop was floated on the stock market as GUM plc. At last they were able to get rid of the political commissars who had second-guessed their every move. Share options made some of these managers millionaires.

They were less happy a few years later. The store was the only supplier of food in its region, so everyone agreed that there had to be regulation of its prices and of the quality of its stock. An office to do this had been set up in Moscow, 3000 miles away. After receiving the most sophisticated economic advice the office undertook regular reviews of the organisation of the store and of its investment plans. It insisted on detailed justification of its operating costs to see whether price levels were justifiable. The office saw no need for the store to earn more than the cost of capital on the amount GUM plc had paid the government for the business. Running a monopoly in such circumstances was a low risk activity.

By this time, the stock market had lost enthusiasm for the business, preferring to support dotcoms and mobile phone companies. The managers’ stock options were buried in the permafrost. They realised that negotiations with the regulator’s office in Moscow were very much the same as negotiations with the central planning agency in Moscow had been in Communist times. The same scrutiny of investment and operating plans was involved. And the familiar tricks of disinformation, practised in the era of centralised state control, came in useful.

Everyone agreed that what was really needed was to introduce a competitive market. But how could you do this while maintaining economies of scale? Some consultants came up with an ingenious solution. They invented the store with two doors.

One of the doors was franchised out to Tesco, and the other to Sainsbury. Each retailer devised an attractive fascia to persuade you to enter by its door. If you went through the Tesco door you paid at the Tesco checkout and if you went through the Sainsbury entrance you paid at the Sainsbury checkout. Inside the store, however, everything remained unchanged, and Tesco and Sainsbury paid to GUM the fraction of the takings that corresponded to their share of the customers.

These Siberians and their advisers had simply missed the point of capitalism. They had confused some of the trappings of a market economy with the essentials. Stock market flotations, share options, and brightly illuminated logos and displays are the flummery. Determined rivalry between different suppliers is the essence.

The history I have recounted did not really happen in Russia. It is the story of water privatisation in England and Wales. The development of regulation since 1989 increasingly and inevitably, involved central supervision of what should, in a market economy, be the commercial decisions of local managers. And the main novelty proposed is a spurious form of competition – the same pipes, the same water, just a choice of the address to which you pay your bill.

The model on which the water industry was privatised was flawed from inception. A water company is a monopoly providing an essential public service. It raises its revenue from charges which are more like taxes than payments for services. Such an organisation was never likely to acquire the legitimacy which attaches to a successful private company in a competitive market. And having failed to acquire that legitimacy, the water industry today feels beleaguered, battered by the regulators, loved neither by their customers nor the stock market.

Kelda – which was called Yorkshire Water when it had to deliver its products in tankers to Halifax and Huddersfield – had devised an ingenious escape through a form of mutualisation. Following a sceptical review by the regulators, this scheme will not now go ahead. It does not fit a regulatory structure intended for a different world. And the problems of governing and capitalising a mutual company are obvious.

But some version of the proposal deserves to succeed. Public ownership of the infrastructure assets, with several companies competing for operating contracts to manage them, would have been a better initial structure for the industry. It would have created an alignment of the interests of customers and managers, and it would have established competition where competition is possible: not in the provision of water itself, but in the provision of the services needed to make water available.

The question is how we get there. Kelda’s specific proposals may fail, but the issues the company has raised will not go away.

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