PERFORMANCE. Costs and performance report This report examines Scottish Water s costs and performance in Overview.

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1 PERFORMANCE Overview This report examines Scottish Water s costs and performance in Contact Katherine Russell Director of Corporate Affairs and Customer Service T E enquiries@watercommission.co.uk

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3 INTRODUCTION Context We are determined to make sure that Scottish customers receive value for money from their water services provider. Scottish Water s day-to-day running costs account for around a quarter of the money it spends, and customers pay these costs directly through their bills. We therefore monitor Scottish Water s progress in this area very closely. Ministers set objectives to improve water quality, environmental performance and customer service. We set prices that provide Scottish Water with sufficient resources to meet these objectives provided it meets our expectations of improved efficiency. This report examines the progress Scottish Water has made in delivering improved performance and in lowering its running costs. We will report on Scottish Water s expenditure on capital investment (that is, investment to maintain and improve its assets) towards the end of the regulatory control period. INTRODUCTION Associated documents Costs and performance report ,, November Customer service report ,, October The Strategic Review of Charges : The final determination, Water Industry Commission for Scotland, November

4 KEY MESSAGES KEY MESSAGES Since Scottish Water was formed in 2002 it has made excellent progress in reducing its running costs. We are pleased to report that it has reduced its operating costs for five years in a row. These costs are now some 40% lower than they were. As a result customers are saving more than 3 million a week 1. Customers are already seeing the benefits of Scottish Water s lower costs in their bills. Water and sewerage bills in Scotland now compare well with those in England and Wales. The prospects for future bills in Scotland are also good, as Scottish Water continues to meet and beat our expectations of improved efficiency. In , Scottish Water s running costs were around 5% better than our expectations. This outperformance is an early indication that the clear incentive framework that we put in place in 2005 is serving the interests of Scottish customers well. Scottish Water has not cut its operating costs by cutting corners. At the same time as reducing its costs, it has improved the level of service to customers 2. Scottish Water must not, however, be complacent. Looking forward, there is scope to improve customer service further while maintaining its recent progress in controlling costs. 1 All numbers in this report are in prices. 2 2 The overall performance assessment is a customer service index that is commonly used in the water industry. Our Customer service report (published in October 2007) provides further information about Scottish Water s performance.

5 PERFORMANCE ASSESSMENT Overall progress For the fifth year in a row Scottish Water has improved its efficiency. Scottish Water s operating costs are now around 40% lower than those of the three former water authorities. Its customer service performance, as measured by the overall performance assessment (OPA) is also considerably better. Figure 1 summarises these improvements. Figure 1: Scottish Water s costs and performance Cost (annual operating cost) million 268 million PERFORMANCE Performance (customer service score OPA) Impact on customers bills As a result of its lower costs, Scottish Water has saved around 1 billion since Customers are seeing the benefits of this through lower bills, which now compare well with those for customers in England and Wales, as Figure 2 shows. Figure 2: Average household bills in Scotland, and in England and Wales household bill Thames Severn Trent Northumbrian Yorkshire Scottish Water Southern United Utilities Anglian Wessex ^ Dwr Cymru South West 3

6 PERFORMANCE Future outlook for bills The outlook for bills in Scotland is also positive by comparison with those south of the border. Figure 3 shows the likely average bills up to Figure 3: Forecast average bills in Scotland, and in England and Wales Average bill ( ) 350 England and Wales 300 Scotland Progress on operating costs Scottish Water s operating costs in were 170 million less than the level inherited from the three former water authorities. Figure 4 shows Scottish Water s year-on-year progress in reducing its operating costs. Scottish Water s achievement is unprecedented in the UK water industry. Not surprisingly, however, the pace of change has slowed as areas of excess cost become harder to identify and as improvements in customer service continue to be required. Figure 4: Scottish Water s progress on operating costs 450 Operating expenditure ( m) Fifth year of reductions in a row Overall improvement 40% Figure 3 shows expected average household bills before inflation. 4

7 Incentives a clear framework Our final determination included six important steps designed to strengthen the governance of Scottish Water and create appropriate organisational incentives. These involved: proper limits on Scottish Water s costs if managers fail to meet expectations, costs will be met from public expenditure, not from customers; a temporary loan facility ( 50 million until 2010) to cover unexpected costs such as emergencies or changes in legal obligations, but not the costs of management failure; a growing savings account (or gilts buffer ) to replace this facility, financed by outperformance of our expectations; transfer of savings to customers after four years, keeping bills down; bonuses to Scottish Water s management that can only be paid when our expectations are beaten; formal scrutiny every three months of Scottish Water s delivery of the investment benefits required by Scottish Ministers. Early indications are that this framework is working well. We set our expectations for improved efficiency in each year of the current regulatory control period, which runs from 2006 to Our expectations define the limits on what Scottish Water can spend. We are pleased to report that in Scottish Water beat our expectations in operating costs by 5%. PERFORMANCE Incentives raising the bar Customers benefit from the incentive framework that we use in setting prices. Every improvement in costs and performance that Scottish Water makes, allows us to raise the bar further when we next set prices. If Scottish Water were to continue to outperform our operating cost expectations by 5%, we would set prices so that they covered only 95% of the original assumed costs (and we would of course still build in further efficiencies). Similarly, if Scottish Water continues to outperform OPA expectations for customer service, we would rebase our expectations for further improvement over Incentives determining the gilts buffer The fund that we established to hold outperformance both in capital expenditure and operating costs would be invested in index-linked, gilt-edged securities. It would act as a buffer or savings account that insulates customers from the costs of any operational shocks that are outside the reasonable control of management (such as, for example, the impacts of the severe flooding in Severn Trent s area this summer). The gilts buffer would only be accessible to Scottish Water with the agreement of the Commission and Scottish Ministers. 5

8 CONCLUSION CONCLUSION In the past year Scottish Water has done well to reduce its operating costs by more than we assumed in our final determination. It has also improved its level of service significantly. This bodes well for the level of prices that customers will have to pay in the future. We trust that the good performance in operating costs and improving levels of service will be complemented by an improvement in Scottish Water s delivery of its capital investment programme 4. 4 For more information, see our Investment report

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12 Ochil House, Springkerse Business Park, Stirling FK7 7XE. T F E enquiries@watercommission.co.uk