Examination of Witnesses (Questions 60-79)
MR PHILIP FLETCHER, MR CALLUM MCCARTHY AND MR DAVID EDMONDS
WEDNESDAY 8 MAY 2002
60. If I was reading the Report correctly I would have difficulty putting down that you have managed to meet efficiency targets, would I not, in a lot of respects?
(Mr Edmonds) You need to look at the legislation. You need to look at the amount of casework that is coming into OFTEL. You need to look at the amount of competition that is now there. You need to look at the success we have had in opening up the BT network to competition. You need to look at innovations such as unmetered Internet access. A whole new area was opened up by OFTEL intervention two years ago. We have got unmetered access at some of the lowest prices in the world. That has been brought about by OFTEL intervention. It has taken more qualified staff. 50 per cent of my staff are professionally qualified. If you wanted me to do a cost benefit analysis of OFTEL, I could do that for you in terms of the benefits brought to the UK consumer. I am not going to apologise for spending more, as you can hear.
61. Benefits is quite difficult but even more difficult is technological improvements bringing certain benefits to the consumer. What I would have expected is once the initial cost of setting up and establishing the regulations for the industry, the roll-out effect year-on-year would be to reduce the number of staff and reduce the costs so that you have falling costs. If you have got some more regulation to impose or the Government has asked you to take on different duties, there might be a step up again but that would come down again. Is that the pattern or are you just saying, "We have got a set number of staff and a set amount of money and you are going to spend that irrespective", because that means we are continuing to have the same level of bureacracy and burdensome red tape and it will never be eased. Which is the better?
(Mr McCarthy) If I can say in terms of OFGEM we have reduced the number of staff over the last two or three years from 380 to a nominal total of 330 and an actual total of 300. I expect to make further reductions in staff numbers over the next two years.
(Mr Edmonds) My organisation is being merged into OFCOM through legislation about to be brought before this House. Clearly there will be in the creation of OFCOM the scope for efficiency savings in terms of back office support. I am trying, and I hope I always do, to give you honest answers. In terms of work coming into my organisation, in terms of requests to me particularly from other telecommunications companies for complex determinations in how they interconnect with BT and the prices they pay to BT, and in terms of complaints to me under the Competition Act that is a workload that is continuing to increase.
62. Some people would say—not me of course—the problem is that your methodology of fixing prices is so complicated and complex you are justifying your own existence and it could be greatly simplified. Would you say that is an over-simplification?
(Mr Edmonds) I think there is some fairness in that. In answer to one of the earlier questions all of us said that we would like to make it more simple and reduce the information demands and we are working consistently on that. If I take you to this Report and what it covers in terms of my workload, it is £300,000 out of a total cost to the organisation of £19 million so most of the work of OFTEL is not concerned with price control reviews but much more complicated disputes between other companies and BT. The Competition Act disputes have got to be addressed in terms of proper process because at the end of the day we are in a quasi judicial position so there is a lot of very complicated work, which I genuinely believe is unavoidable. The Atkins Report looked at all of us, including OFTEL, and gave us a pretty clean bill of health in terms of our efficiency in running the organisation.
63. Can I ask one particular question which has always fascinated me on the cost of using different fuels and I think the term is "dash for gas" which enables the energy producers to reduce costs dramatically. It is one of the reasons we have got cheap electricity. Do you have to consider in evaluating the industry itself the proposals it makes on where it gets its fuel, the security of supply, the efficient use of that fuel for the nation? Are they within your remit at all?
(Mr McCarthy) In terms of the businesses that we price control, for example transport businesses, those questions basically do not arise, other than the very important questions of the security of supply and investment in the network, and that is a question that we constantly address and it is that sort of difficult question that makes the ideal of simplicity of price control difficult to attain.
64. I know the CEGB when it was operating had a development department which was decimated. We have done nothing with regard to the supergrid or advances in generation since it got privatised which is a shame. If it is not in your remit I cannot pursue that. To turn to something that is within your remit. Some of my constituents have been hoodwinked by companies coming round and getting them to sign up to new deals and new suppliers. It is sharp practice and they have taken a long time and a lot of trouble to get disentangled from that and get back to the original supplier. How are you treating this?
(Mr McCarthy) Very seriously is the very brief answer. We have been particularly concerned to do two things, and one is to stop this abuse at source. It is not frequent in the sense it is a very low proportion of all transfers that take place. Having said that, it is an abuse that we should try and stop and we are working to stop. OFGEM has extended for two years particular licensing conditions governing marketing of gas and electricity. We have taken action against specific companies whose marketing practices were unacceptable. The second thing we need to do is when there has been a mistake, either because of the abuse of marketing techniques or for some other reason, to make a much simpler process for a customer to go back to the original supplier and we have introduced something called the Erroneous Transfer Charter which we and Energy Watch together devised to make it much easier for a customer transferred against his or her will to go back to the original supplier.
Mr Jenkins: I have run out of time unfortunately.
Chairman: Thank you, Mr Jenkins. Mr Geraint Davies?
Geraint Davies
65. Good to see you all again. Mr McCarthy, the RPI—X model is obviously supposed, as we have discussed already, to mirror the market competitive ethic, but in a sense would you say that the profit motive implicit in that, namely the opportunity to reduce costs against a price ceiling, is a stronger entrepreneurial motivation that is facing the market-place when a lot of motivation is not profit maximisation but is actually competitive survival? Do you think it would generate a different result?
(Mr McCarthy) I do not know, but I am clear that the position that is faced by all the companies that we price regulate, all of whom are monopolies and all of whom are natural monopolies, makes it impossible for there to be the degree of entrepreneurial activity in a competitive market, which is the model that you are postulating.
66. We have already asked all three interviewees here about why there is a different rate of average price reduction and what has been explained, as I understand it, is different exposure to competition alongside different technological cost efficiencies. It is quite difficult to make an inference about one of those. Would it be reasonable to say, starting from the left, that had there not been that level of competition, the straight regulatory RPI—X would have delivered less of a price reduction?
(Mr Edmonds) Your question is that the RPI—X would have delivered less of a price reduction in what circumstances?
67. There is a certain level of competition and what is is happening is that you are imposing a regulatory regime within a context where there is competition emerging and therefore rational operators will have to fight harder to get prices down not, just because you tell them to but because there is competitive advantage in so doing. Mr Fletcher's scenario seems to be to obey the price reductions. They say it is terribly unreasonable and meanwhile they make a bit of a profit out of the cost reductions, but they are not in a competitive environment so they are not working very hard, they are just sailing along. Do you think there is reason to think that?
(Mr Edmonds) There is more similarily between the core businesses than your question implies. The BT network, which is again the subject of this Report, is a natural monopoly. It sits there at the heart of the company. The incentives of the people within that business to run it efficiently in a world where there is no competition for most of the services and most of the products that they provide, is much less obvious than in a truly competitive world. Therefore, I think the outcome of the quite tough price controls that my predecessors and I have applied is to drive out greater efficiency and is to simulate, as we answered in response to an earlier question, a world of competition. I suspect that the difference is not quite so great at this wholesale central network level as in the rest of the network where, yes, there is competition and much more competition in various parts of the retail market and certainly to the domestic consumer where half of us have got a choice of two infrastructure suppliers, which is not the case in gas.
68. In a real market-place consumers have two choices to make in very simple terms, one is a price choice and one is a quality or services choice, and normally competition is done on the basis of product diffentiation alongside competitive pricing. It seems to me because there is not a proper price or a market-place that what is happening here is we are setting prices, we are not giving consumer choice, we are setting the price but within that context, and if there is any competition that is the context within which price differentiation and product differentiation occurs. Is that not a bit limited for the consumer?
(Mr Edmonds) The consumer at the retail end has a choice that relates to quality as well as relating to price. At the wholesale end there are different sorts of customers. Customers coming into the BT network include all the big telecommunications companies, including mobile companies. They have no choice for many of the products but they do have choice for others. So it is a very complicated world of telecommunications which is why I think that the continuation of the price control in the foreseeable future will remain fundamental in terms of driving price down. There is an enormous incentive on BT to provide a high-quality service but do not forget it is selling to itself as well as selling to Colt, Energis, Vodafone and the other mobiles. It is selling to a range of big consumers at this level who are then selling on to the retail market.
69. Maybe my question is more pertinent to Mr McCarthy, the question about you can hammer price but in some sense that limits quality and innovation. Do you want to comment on that or not?
(Mr McCarthy) In terms of the businesses that we price control, where I keep coming back to the point that each of them is a monopoly, there is indeed very limited opportunity for quality offerings. It is possible for sophisticated customers to do deals which give the system operator the right to interupt supply and charge a different price as a result of that. One of the responsibilities that I think it is entirely proper for us to have is that it would be unrealistic to expect each of us as domestic consumers to set the level of reliability that we want to pay for in terms of when we switch on the light will the light come on. One of the things we do and we do very explicitly is to set standards of that nature for the distribution businesses which we price control. Rather like the position that David described from telecoms, once you get to the retail market there is very genuine competition and that competition is on a combination of price, quality and of brand name.
70. Mr Fletcher, do you want to respond?
(Mr Fletcher) It is a different set of circumstances. The roughly four per cent per annum efficiency gain in the sector since privatisation in 1989 is largely down to the endeavours of the companies spurred by economic regulation rather than competition, helped to a degree by new technology but certainly not sailing along. I may have slightly misunderstood you on this but I am quite convinced it has been hard work for the companies and it would not have been readily achieved without my predecessor's strong pressure on the companies through RPI—X.
71. I do not mean to pick on you particularly but it seems to me that in any competitive market-place there would be opportunities to do market research and check what consumers want. They might want greater clarity of water out of their taps if they had a number of choices but obviously they are not in that position, so how do you mirror customer wants and then ask the suppliers to deliver those in any sense? Do you do that in any way?
(Mr Fletcher) We do try to. First of all, we try to be fully accountable in what we do. For example, we publish a series of reports every year which show what has happened to various indicators of quality performance. If I pick up from my colleagues properties subject to unplanned supply interruptions, that particular one has been reduced from 0.4 per cent of customers (not all that great) in 1991 to 0.1 per cent of customers in 2000-01. That is one way forward. Another issue is properly consulting customers at appropriate points in the regulatory cycle on what really matters to them. We have learned that from the last periodic review and as we look towards the next one we are working with the companies, with WaterVoice, that is the customer representative, with government departments and quality regulators, to seek to ensure that we launch a combined customer survey which will give us as good a picture as we can in what admittedly are more artificial circumstances of what a customer would want if he had a choice about where he could turn.
72. Let me ask about the basics of infrastructure of the system. I was driving down somewhere called Addington Road the other day when there was very strong rain and regrettably all the holes in the ground were spewing out sewage. What is your feeling about the adequacy of the infrastructure now that there is more tarmac down, more run-off basically going down these drains and more people are using more water through various washing machines? In terms of where we are, in terms of capacity usage, we are nearer to the level when, if we have a big downpour, we have this unfortunate output. What is happening about that?
(Mr Fletcher) Of course with the infrastructure we are looking back to Victorian times, so we are looking at a basis which is not particularly ideal, and in particular we still have a great many drains which serve dual purposes. As I was saying earlier on, the cases of sewer flooding, pure and simple, that is sewers which are blocked or fail and lead to sewer flooding, are pretty small, but especially the winter before last we had householders suffering from "normal flooding" as a result of very heavy rainfall—what you were experiencing—but there tends to be, because of the shared drains, an element of sewage/run off from fields which leaves a very, very unpleasant after-effect for any householder.
73. All this stuff goes down one pipe and has to be then processed as sewage, so if you had two pipes with one dealing with rainwater, we would not have to go through the expensive system of processing and would avoid overspill. Is there any prospect of the industry generating a dual system?
(Mr Fletcher) It probably would not be cost effective to create from scratch a whole new dual system, leaving alone the disruption to the roads which would be brought about.
74. How will the regulated current system deliver an output in the foreseeable future which means we do not have sewage spilt all over the main roads every couple of months?
(Mr Fletcher) One of the issues we are working on, or rather the industry is working on, financed by the price limits, is the whole business of these combined sewer outfalls and the unsatisfactory ones are being dealt with largely over this particular periodic review in order to deliver the standards required under the Urban Waste Water Treatment Directive, the European Directive. So this is something for which the price limits provide for 2000-2005 for the water and sewerage companies to make substantial improvements.
75. Are you instructing them to do this? Obviously the regulatory regime is in terms of a framework rather than, "You stop this burst", and in terms of consumer choice all we have is a situation where they have variable prices and sporadic eruptions of sewage in the streets. Where is consumer empowerment there?
(Mr Fletcher) The £50 billion-worth of capital expenditure which is taking effect between 1999 and 2005 is heavily influenced by the quality programmes which effectively are set by the Government, by ministers in the Department of the Environment, Food and Rural Affairs, on the advice largely of the Environment Agency and the Drinking Water Inspectorate and which I then take into account in setting price limits. So although we seek, and this is a combined effort, to set the outputs in terms of the outcomes, the achievement of the quality gains, nonetheless for that big element of the capital programme it is fairly carefully specified what has to be done.
76. To make sure I have this right, am I right in saying that you have the power to specifically say in an instance where there is—and I am using this example as illustrative—this awful unacceptable smell and output on a regular basis, "We want you to fix that", or are you simply saying that you want people to be happy? If you have not got the power to do that, there is no consumer empowerment, there is nowhere else to go, and it seems to me all you are doing is setting a price ceiling where there can be a rate of return which is acceptable to investors—and indeed there are these issues of people pretending operational expenditure is capital expenditure. Can you actually go in there and say, "Do that in the interests of the consumer" or not?
(Mr Fletcher) Smell is a particularly difficult one because it is an issue that tends to fall across a number of different regulatory legislative bodies. Nonetheless, it comes into the pattern. The endeavour under RPI—X is to say that it is the companies' job as efficiently as possible to construct their capital assets through good procurement and good management of their contractors to deliver a different output in terms of—
77. But can you do it? Yes or no?
(Mr Fletcher) Yes, you can to achieve—
78. To stop that smell in that road?
(Mr Fletcher)—the Directives. For example, on drinking water to ensure that customers are not threatened by lead in drinking water, in sewage treatment work to ensure bathing waters are of the right quality.
79. So I am right to say you can sort it out, that is the way the system works?
(Mr Fletcher) That is how it works.
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