Thorough cost scrutiny can yield 7% savings

Water firms have a tough price determination to deliver. Terry Povall says scrutinise existing costs before rushing to cut jobs.

Most water companies have now accepted Ofwat's determinations 2010-15, and several are now embarking in earnest on programmes of cost reduction to meet the challenges set for them. These programmes have been brewing for a while, with many companies questioning where costs can be saved since Ofwat's draft proposals were published last summer. Some are looking to reduce headcount outright; others to transfer staff to contracting organisations; others to shave procurement costs in some way.

It is true that, if you look hard enough, inefficiencies can almost always be found. But aggressively attacking the cost base can be dangerous. It may leave shortfalls in capacity and capability, risking service to customers and the company's reputation. Before water companies think about making such reductions, they should make sure they understand their cost bases fully and are not missing easier wins.

Hidden inefficiencies

In recent years, EC Harris's review of expenditure for several companies has revealed hidden inefficiencies associated with poorly monitored capital and operational expenditure. This has stemmed not from any fraudulent cost management, but from insufficient data quality, weak financial controls and limited visibility of suppliers' systems and processes. These inefficiencies can lead to programmes financially overrunning and costs spiralling, raising many questions about governance.

This can potentially cost utilities millions of pounds and badly damage their relationships with their suppliers. If utilities do not change their approach when their actions produce poor results, it can foster a blame culture between them and their supply chain. This can create strategic misalignment due to each party misunderstanding the other's corporate goals.

Audit all costs

To prevent such unnecessary problems occurring, water companies should conduct a full, 100 per cent audit of actual costs on open book contracts, as opposed to merely sampling. Such a rigorous approach to forensic cost assurance can often deliver significant cashable savings of between 3 and 7 per cent and play a major part in releasing the more challenging efficiency gains. In fact, this approach can uncover years of missed opportunities.

For instance, bad data management can be brought into the spotlight, creating immediate bottom line savings and identifying areas for improvement in continuing processes, procedures and practices, which can lead to further savings over the longer term.

Moreover, a forensic cost assurance approach maximises value during project or programme inception, construction and operation, driving potential savings back through the supply chain. In a recent example, EC Harris identified a saving of £14 million in a £200 million annual programme. In another, the approach turned up savings of £6.8 million in a single project.

At a time when both Ofgem and Ofwat are driving for significant efficiency savings from utilities, it makes sense, before rushing to reduce headcount or slash costs in other areas, to make sure existing costs are actually what they seem. A 7 per cent reduction in actual costs would not be a bad starting position in the first year of this tough determination.

Terry Povall is partner and head of utilities at EC Harris.

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