MD138

TO MANAGING DIRECTORS OF ALL

WATER AND SEWERAGE COMPANIES

AND WATER ONLY COMPANIES

30 September 1998

BUSINESS PLANS FOR THE 1999 PERIODIC REVIEW

I have to decide on price limits for your company for the five years 2000-01 to 2004-05. These decisions will have to be taken in the light of a number of assumptions. In particular, I will clarify the standards of service, reliability and quality outputs that are to be delivered by your company in return for the revenue streams provided within your price limits.

My price decisions will amount to a regulatory contract. Your company will be monitored annually against this regulatory contract throughout the five-year period.

Your Board has to decide at the Review, therefore, what it wants to do and what proposals it needs to present to me, in order to carry out its functions and deliver specified standards and outputs to its customers.

Following my decisions, your Board has to decide whether it accepts the numbers I will determine or have the matter referred to the Monopolies and Mergers Commission (MMC).

I wish to continue to engage you and your Board in a process of strategy formulation and dialogue.

BUSINESS PLANS

In early April next year, your Board will need to provide me with a Business Plan setting out what it wishes to do in the five years 2000-01 to 2004-05 and asking for specific price limits to enable your company to do that. At the same time I will receive separate reports from the Reporter and Auditor summarising their respective audits of your company's information.

The plan will be your company's plan, and presented in the way you consider most effective. However I do require consistent presentation in both subjects covered and consistent data tables, either within the text of the plan or annexed to the plan, so that I can make such comparisons as are necessary for me to carry out my statutory duties. Information submitted to me by your Board in support of the price limits it considers necessary for your company should be systematically related to what I need to decide. The plan should expose the big issues, highlighting any uncertainties or potential disagreements between your company and me. I will need sufficient information to set price limits in accordance with my statutory duties; to publish an explanation of my conclusions and set out supporting information, such as the scale of the capital expenditure programmes.

The Business Plan should be shorter and more focused than the 1994 strategic business plans. The plan will represent a drawing together and refinement of the various strands exposed during the course of 1998.

The Business Plan should be in two parts:

A The company strategy

B Key components

Your company strategy (PART A)

This is the heart of the Business Plan. It will set out your company's objectives for the five years 2000-01 to 2004-05. It will identify where your company is, where it wants to be and in broad terms how it will get there, under the following headings:

• Your Board's overall strategy and its implications for price limits and average bills.
• How and why you believe the strategy achieves the right balance between service levels, prices and tariffs for your customers, and meets their expectations as to priorities for improvements.
• The current situation with particular emphasis on the environment in which you will operate in the next five years and customer and community expectations.
• Your company's strategic objectives for the period 2000-01 to 2004-05 in terms of:
  - service performance outputs

  - quality and environmental outputs

  - other outputs,

  all set against the context of maintaining current performance for customers and compliance with environmental requirements.
• How these objectives translate into activity/work you consider will be necessary in the period and to what extent you can improve the efficiency during the period in light of your assessment of current performance and the scope for improvements.
• The expenditure that your company will need to make to achieve the strategic objectives in the light of the planned activity and improvements.
• Finally, how your Board's strategy translates into financial projections for your company.

Your company's strategy should be formally endorsed by your Board. I would like to be assured that your parent Board, as well as the Board of the appointed business, supports the strategy. I undertake personally to read your strategy on the expectation that it will be read and endorsed by all the members of your Board.

I enclose my views of what should be covered in Part A of your Business Plan.

Key components (PART B)

The key components part will outline what must be done to achieve the strategy and should be endorsed formally by you. Key components have been broken down into eight sections:

• the post-2000 environment;
• improvements in efficiency;
• maintaining service and serviceability to customers;
• quality enhancements;
• maintaining the supply demand balance;
• customer service strategy and service enhancements;
• financial projections; and
• customer bill and tariffs

Your plan for future services

You may wish to publish the whole of your Business Plan in April 1999. I enclose what I see as the minimum requirements for a summary of your plan that you will need to publish in April 1999. This will enable the periodic review dialogue between you, your Board and me to continue and involve all other interested parties.

Also please supply a single page summary of your company strategy for the Ofwat web site and library.

Supporting information

Supporting material, some of which will be required and some of which is optional, will cover:

• detailed evidence of customer views;
• benchmarking and efficiency studies;
• cost base;
• asset inventory;
• quality enhancement programme database;
• supply demand submission;
• service enhancement costing; and
• leakage appraisal

Your Business Plan should be subject to effective scrutiny and challenge by the Reporter and Auditor. In particular I will ask the Reporter to review whether there are adequate audit trails linking what is said in your Business Plan to the supporting information. Both will need to submit their reports to Ofwat in April 1999. Please work in conjunction with your Reporter and Auditor to ensure that the Reporters have the information to carry out a thorough and effective audit of your Company's Business Plan before it is submitted to me.

My staff will analyse the Key Components part of your Business Plan, the supporting information and the reports from the Reporter and Auditor and advise me on their implications for price setting.

THE BUSINESS PLANNING PROCESS

In the remainder of this letter, I wish to confirm the process of strategy formulation and dialogue with you and other companies.

In the next few days Ofwat will be issuing guidance on the update of quality costing. This submission will be required in mid December and be used to inform the final decisions on quality obligation early next year, following the Government's guidance on environmental and quality obligations that the industry will be required to deliver in the period 2000-05 (Raising the Quality – DETR/WO September 1998).

My paper, Prospects for Prices: strategic options and issues, will be published in late October 1998 and provides the basis for working level discussions with your company. During January or February 1999 a formal meeting has been arranged with your company to discuss the issues raised in Prospects for Prices and how your company intends to deal with them in its Business Plan. This meeting will provide the final opportunity for your company to discuss matters with me prior to your submission. The meeting will not set out to reach agreement on issues, but rather to identify where our respective positions may be unclear on material issues and to achieve greater understanding of them.

If the process has been successful there should be no material issues raised by your company in its Business Plan in April 1999 of which I am unaware from my meetings with you. Equally you should be aware of the key points in my own approach and how they apply to your company.

I will approach my review of Business Plans, therefore, on the basis that material issues will already be known, and will have been raised by you. By the same token, I believe that your Board should be aware in broad terms of my likely reaction. I do not expect issues to be raised for the first time in Business Plans.

Decision making

I will prepare my draft determinations in the period from early April to end July 1999. By 1 June 1999, you should send me your company's annual returns for the financial year 1998-99.

I will publish in late July 1999 the draft determination in a report setting out the individual company K factors, infrastructure charge limits and the outputs required during the five years 2000-01 to 2004-05. At the same time I will write to you with an explanation of factors behind the draft determination specific to your company.

A period of external consultation and comment on the draft determinations will follow. I will hold a formal meeting with your company to listen to its representations on the draft determination before I make my final determination in November 1999.

Implementation

The Business Plan will then be rolled forward into the monitoring base for regulation in successive years. I am expecting your company Board to prepare and publish a final Business Plan (AMP3) identifying the outputs that it will deliver year-by-year during the five years 2000-01 to 2004-05 together with the implications for customers' bills. This monitoring base will also indicate the expected expenditure levels and key activity profiles through the period as set down in the final determination.

On 1 April 2000 the new price limits will come into force.

Your company performance, reported annually in July Returns and Regulatory Accounts, will be monitored relative to that assumed in the final determination and set down in the final Business Plan (AMP3).

I C R Byatt

Please click here to access annex to MD 138.