Value Management and Risk Management in the Water Industry

Kevin Luff
The Water Industry is entering a new era in its business planning for Asset Management Plan 6 as required by Ofwat’s document 'Setting price controls for 2015-20 – final methodology and expectations for companies’ business plans'.

Ofwat’s focus is on a holistic approach of "Outcomes" and "Totex" and not outputs and inputs. Ofwat defines within Future price limits – a consultation on the framework [1] the following:

  • Outcomes are the higher level objectives that company actions, activities and achievement are intended to help deliver. They represent what customers and society really value.

  • Outputs are the observable and measurable activities, actions or achievements that a company needs to deliver to bring about the outcomes that customers and broader society value.

  • Inputs are the resources that a company uses to carry out its activities or to deliver particular outputs.

  • Our focus here is on a totex approach. This considers opex and capex together and looks at the overall expenditure requirement in a more holistic way. [2]

It is clear from this, that value is a key driver in Ofwat’s approach which infers the need for value management (VM), to provide a structured approach to delivery and the decision-making process. Ofwat’s outputs definition also includes ’It may be possible to achieve an outcome by means of different sets of outputs’; a fundamental premise of VM is that there are multiple approaches to achieving an objective. 

In summary, value is defined as function or objective divided by cost/resources required to deliver...

VM aims to identify the best value solution in terms of cost/IRR (Internal Rate of Return)/NPV (Net Present Value) to satisfy defined functions or objectives, to create sustainable whole life value for organisations, stakeholders and their customers. In summary, value is defined as function or objective divided by cost/resources required to deliver, which translates in Ofwat terms to: 

Value cannot be maximised without understanding comprehensively the benefits and delivering the necessary improvement. In addition, value cannot be maximised without considering the risks (threats and opportunities) being faced; likewise, risks cannot be managed without considering the impact on organisational, programme of works or individual project value. Ofwat’s risk-based review process to test business plan submission quality [3] includes:

  • Risk and reward – how the company’s proposals balance risk and the rewards for bearing those risks between consumers, including current and future customers and the environment, and the company and its investors.

This definition emphasises the need for risk management (RM) and the allocation of risk to the party best placed to manage it. RM should be implemented with a view to providing a framework to enable a clear understanding of risks, opportunities and uncertainties and their quantification and management. This should negate unnecessary transfer or eradication, which in turn can induce longer-term cost implications and prevent efficient delivery.  

Ofwat’s clear aim throughout their consultation and review process was to re-think the way it undertakes Price Reviews and also the way water companies deliver them. Ofwat’s determination process will challenge the water companies’ in delivering their defined outcomes against appropriate Outcome Delivery Incentives (ODIs).

In order for the water companies’ to meet this challenge, whilst maintaining stakeholder returns, there will need to be a definition of 'true value'...

In order for the water companies’ to meet this challenge, whilst maintaining stakeholder returns, there will need to be a definition of 'true value' and not simply minimising risk with engineering/construction outputs. This requires a clear understanding of objectives, separation of the needs and wants, as well as a structured and auditable resolution. This would require appropriate level of risk and reward in order to provide a balanced, sustainable and value focused result for customers, stakeholders and the company alike. In essence, a fully integrated VM and RM process during delivery which would be achieved via the following:  

  • A clear understanding of the changing regulatory environment,

  • High level water company management buy-in and leadership to the process including innovative and fresh ideas,

  • Commitment of both internal and external resources, and

  • Employment of focused competent practitioners to facilitate the process.

The benefits of an integrated VM and RM process in delivery of Asset Management Plan 6 (AMP6) and beyond will allow the water companies to provide: 

  • Defined longer term plans related to the service customers want and receive.

  • Focus on what it needs to be achieved and its' develop in the most efficient and effective way.

  • A clear link to their customers’ and stakeholders’ needs and priorities.

  • Greater scope to innovate in how they achieve the agreed outcomes and realise the required benefits.

  • Clarity for customer and supply chain engagement in the long term objectives.

References

[1] Ofwat – Future price limits – a consultation on the framework – Appendix 2 : Inputs, outputs and outcomes November 2011

[2] Ofwat – Future price limits – a consultation on the framework – Appendix 7 : Cost assessment, cost recovery and the RCV November 2011

[3] Ofwat - Setting price controls for 2015-20 – final methodology and expectations for companies’ business plans July 2013

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