Ofwat publishes independent report into vertical integration, and economies of scale and scope
We commissioned an independent report into vertical integration and economies of scale and scope.
A link to the report is below.
Company structures
Supplying water and sewerage services to consumers involves many different functions. For water, this includes abstracting water, treating water, distributing water and retailing. For sewerage this includes sewage collection, treatment and disposal, and retailing.
There is currently some debate about how water and sewerage companies should be structured – whether there should be:
- single companies that perform every activity involved in providing a water and/or sewerage service(vertically integrated), or
- separate companies to perform to perform discrete functions.
Currently, water and water and sewerage companies are organised as vertically integrated companies.
Economies of scale and scope
A water company experiences economies of scale if the average cost of supplying a water or sewerage service per property falls as the number of properties increases. This may be because there are fixed costs that can be shared amongst a larger number of customers.
A water company experiences economies of scope, if the average cost of carrying out two activities together are less than the cost of carrying them out separately. This may happen when for example, the two activities are similar, so can use the same equipment or expertise.
Why did we commission this research?
Some commentators and water companies argue that the vertically integrated water companies have significant benefits from both economies of scale and economies of scope.
Other commentators argue that the benefits of economies of scale and scope are not significant for vertically integrated water companies. Indeed, in some cases they have argued that separating the companies could generate greater efficiencies.
We commissioned Dr Michael Pollitt of Cambridge University to assess whether water companies need to be vertically integrated to achieve economies of scale and scope.
Conclusions
Dr Pollitt assessed much of the early literature on the subject. He found that while some studies pointed to a loss of economies of scope from separating companies, there were other studies which showed that scope economies could still be realised between separate companies.
Further information
Michael Pollitt and Steven Steer, Economies of Scale and Scope in Network Industries: Lessons for the UK water and sewerage sectors, August 2011
