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As at 12.37 on 8 September
Tips and Traps.
A director's guide to the new water
pricing framework in Victoria
Dr Ron Ben-David Chairperson
Essential Services Commission
Presented to the VicWater Annual Conference (9 September 2016)
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Abstract
In this paper, Dr Ben-David briefly reflects on the reasons why the Essential
Services Commission considered it necessary to modernise the way it approves
prices proposed by the State’s regulated water businesses. In developing the
new framework, the Commission adopted four high level objectives
concerning: Customers, Autonomy, Performance and Simplicity. Beyond
these four objectives lie three central mechanisms that thread their way
through the framework binding it into a comprehensive whole. These
mechanisms are: Engagement, Incentives and Accountability. These
mechanisms are not new to economic regulation but the framework imbues
them with renewed vitality. Dr Ben-David outlines 12 key messages to the
water businesses to assist in their application of the new framework.
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Thank you VicWater and Tony Wright for the invitation to present at this year’s
annual conference. The Essential Services Commission has had a long and
productive association with VicWater and we’ve apreciated the opportunity to
present at the annual conference. We value the support that VicWater and
Tony have provided the Commission over the years and we look forward to
building on that relationship in the times ahead.
INTRODUCTION
Since the early 2000s, the Essential Services Commission has been the
economic regulator for the Victorian water industry. In short, this means we
approve service standards, authorise the prices you can charge your customers
and we report on your performance each year. Looking back through those
performance reports, what we see is that in the first few years of reporting
there were marked improvements in performance across the industry. In more
recent years, there has been little change in the overall level of performance.
There has been a clustering of performance outcomes with businesses neither
falling behind the pack nor streaking ahead of the pack. It seems the industry
has settled into a cosy equilibrium. Is this good enough?
It is clear to me from my discussions with all the boards over the years, and
particularly in recent times, that none of the Boards would accept that this is a
good enough outcome. I have been left in no doubt that every Board aspires to
something better. Sometimes those ambitions express themselves in terms of
ongoing business improvement. Sometimes, it’s about making a greater
contribution to the local community or reducing the impact of the business on
the natural environment. At other times it is about the water business wanting
to push the envelope; wanting to be first among its peers.
Throughout those discussions there has been an underlying concern that the
‘one size fits all’ framework applied by the Commission may run contrary to
the ambitions of a business striving for excellence. While I strongly reject that
view, I recognise that it is a view that is held by some in the industry.
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At the same time, I have heard many comments over the years that have
highlighted the lack of clarity among boards about their role versus the role of
the Commission. Some comments have been more memorable than others.
For example, there was the Managing Director who declared on more than one
occasion, “I love economic regulation. The ESC tells me how much money I
have and then I go out and spend it.”
Then there was the Chairman who said, “After we’ve prepared our five year
price submission, there’s really not much else left for the Board to do.”
Other water authorities have openly confided to us that their submissions
contained projects they knew to be ‘duds’. Apparently, the businesses took the
view that it was easier to defer the fate of these projects to the regulator
rather than having the required debates internally.
Then there was the water business that printed on its customers’ bills that the
rise in prices was approved by the Essential Services Commission and
recommended that customers contact the Commission if they had any
concerns.
Admittedly, these are just some of the more colourful examples that I can
recall from over the years. There have certainly been many other less colourful
examples that highlight confusion about the purpose and workings of
economic regulation. I don’t know why this confusion exists, but it does.
All of these observations ― the clustering of performance outcomes, the
desire of Boards to take their businesses to the next level, concerns about a
one size fits all framework, and confusion about our respective roles and
responsibilities ― all these observations told me that it was time that we
seriously reconsidered our approach. Last year, we initiated a project
examining how else we might go about our task of approving the prices to be
paid by Victorian customers for the services provided by the water industry.
We commissioned research papers, hosted workshops, held a conference and
have travelled the State consulting with individual water businesses. This
research and consultation highlighted that the current framework was not
‘broken’ but there were clearly some opportunities for some reconditioning.
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In May this year, we released a paper proposing a new approach to water
pricing. It’s not a long paper and I am trusting today that most of you have
been briefed on the proposal by your staff. I therefore don’t intend to outline
the framework today. Rather, I want to provide you some key message
clarifying how the framework will operate and dispel some of the
misunderstandings that have been brought to our attention over the last
couple of months.
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SOME OBJECTIVES AND MECHANISMS OF THE NEW FRAMEWORK
Before I get to those key messages, I just want to recap on the objectives we
set ourselves in developing the new framework. Some of you will have already
heard me talking about these objectives, so I apologise for the repetition. For
those of you who may be interested in better understanding these objectives, I
refer you to an article we are publishing in an upcoming edition of the ACCC’s
regulatory publication, Network. We’ll make that article available on our
website (along with this presentation).
The four high-level objectives we set ourselves concerned: Customers,
Autonomy, Performance and Simplicity. I shall just briefly outline what each
objective sought to achieve.
Customers. There is no doubt water businesses have taken great strides in
consulting customers about their price submissions. We saw this in 2013 when
all 19 businesses made submissions to us, and we saw it again this year with
the submissions made to us by Melbourne Water and Goulburn Murray Water.
Even so, during our discussions it became clear that water businesses,
consumer groups and regulatory experts all felt much more could be done. We
agree wholeheartedly and this is reflected by the pivotal role customers will
play in shaping price submissions under the framework.
Autonomy. As the examples I gave you a moment ago highlight, it would seem
the current framework either allows or encourages lines of responsibility for
outcomes to be blurred. It is not clear why. There should be no such confusion.
The new framework will leave no doubt about the autonomy of the water
businesses to determine their financial and reputational fates.
Performance. The clustering of performance outcomes in recent years
suggests the businesses have little interest in ‘breaking from the pack’. This
observation has three important implications. First, the outcomes we’re
measuring might not be the things that matter most to most customers.
Second, there are no consequences if a business falls short of the standards to
which it has committed; and third, there are no consequences when
businesses do not strive for better outcomes.
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By ending the enforced one-size-fits-all approach to performance reporting,
the new framework will give businesses the autonomy to pursue the outcomes
of most importance to their customers. Rather than herding with the pack,
each business will now face strong incentives to be innovative in its delivery of
service outcomes.
Simplicity. Our fourth objective is: Simplicity. It’s a terrible irony that it is
much easier to design a complicated regulatory framework than a simple one.
Over the years, we have assiduously protected our framework from
descending into the madding pursuit of false precision that has plagued other
regulatory frameworks. Complexity only serves to disenfranchise consumers.
Complexity drives customers to the periphery of the regulated businesses’
concerns; customers are relegated to being mere and passive recipients of
services. Our new framework embraces simplicity.
*
Beyond these four objectives lie three mechanisms that thread their way
throughout our proposal and bind it into a comprehensive framework. These
mechanisms are: Engagement, Incentives and Accountability.
Engagement: In the future it will not be possible for water businesses to
prepare price submissions without having meaningfully engaged their
customers. Businesses will need to identify their customers’ concerns, interests
and priorities so that their submissions can be expressed in terms of the
outcomes valued by their customers. To be clear, this requirement is not just a
procedural nicety. There will be no satisfactory regulatory outcomes for a
water business which fails to do so.
Incentives. The traditional incentive mechanisms of economic regulation have
proven beneficial in the Victorian water industry, but more can be done. By
linking the level of ambition of a pricing proposal to the rate of return a
business will earn, the new framework will establish a new set of strong
financial and reputational incentives. The framework will reward businesses
that: focus on delivering outcomes sought by their customers; accept risks on
behalf of their communities; and deliver services as efficiently as possible.
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Accountability. Being customer-facing entities, the water businesses will be
held accountable for fulfilling their part of the economic bargain. They will be
responsible for discovering their customers’ preferences. They will be
responsible for determining how ambitious they wish to be when responding
to those preferences. And uniquely, businesses will be responsible for self-
assessing the extent of their ambition. Under the new framework, the
regulator is relegated to assessing the accuracy and veracity of the businesses’
self-assessments. The rate of return businesses earn will depend on the
consistency between these two assessments.
*
Engagement, Incentives and Accountability are not new mechanisms in
economic regulation but our framework imbues these mechanisms with
renewed vitality.
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TWELVE KEY MESSAGES
In the time that remains, I want to focus on some key messages that, I trust,
will help to shape your thinking about how you operate under the new
framework as a service provider, as a Board member or as a business manager.
1. What value do you deliver to your customers?
At my first appearance at this conference a few years ago, I asked the gathered
leadership of the Victorian water industry a seemingly simple question. That
question continues to echo around the industry and even six years later,
people still tell me they’re not quite sure about the answer.
The question played off a brilliant quote from Warren Buffett. Buffet is reputed
to have said, “Price is what you pay. Value is what you get.” That statement is
so simple yet so axiomatic. Picking up on Buffett’s theme, my question to the
industry that day was: “What value do you deliver to your customers?”
When I first posed that question to the water industry, it was as though I was
speaking ancient Aramaic. Non-one had ever asked such questions of the
water industry. Until then, the discussion was always about pipe maintenance,
filtering technologies and billing systems. By talking about ‘value’, I flipped a
century-old paradigm on its head because I insisted that, instead of describing
the industry in terms of what it does, I was going to describe the industry in
terms of what its customers get. It was the recipient and not the producer that
mattered to the regulator from now on.
Much has changed in six years. We’ve observed a marked progression in the
way water businesses seek to communicate and engage with their customers.
As already noted, we saw these changes during the 2013 price reviews and we
saw further steps taken in the two reviews completed this year. The strength
of the commitment from across the industry is to be applauded.
Our pricing framework will take customer involvement not just one step
further, but it will take it into a whole new realm. It would be wrong to
interpret our focus on customer engagement as just doing a bit more of what
most of you are already doing. You see, the way the new framework is
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structured, each business will be required to answer that question I asked six
years ago: “What value do you deliver to your customers?”
Answering that question — a question that has been almost imponderable for
many people in the sector — answering that question will now represent the
central purpose of your price submissions. The answer to that question is what
we, on behalf of your customers, will be looking for as we assess your pricing
proposals.
We will be looking for a clear and comprehensive account that links the
investments and projects you are proposing to undertake and the service
benefits they will deliver to your customers and your strategies for managing
the costs of those investments and projects and the price impact this will have
on your customers and the difference all of this is going to make to your
customers and how all of this takes into account what you have learnt from
your consultation processes.
The team back at the office call these narratives —narratives that flow from
customer to project to service to cost to price to outcome — they call these
narratives “the golden threads” that will bind your submissions into a coherent
story about the outcomes your customers will enjoy. It is this coherent story,
woven together by these “golden threads”, which finally answers my question
about the value being delivered to your customers. It will answer that question
because it will tell customers about the difference you are making to their lives
in return for the bills they are required to pay to you.
“What value do you deliver to your customers?”
“What difference are you making in your customers’ lives?”
The entire framework centres on answering these questions, but a word of
caution. You can’t answer these questions in the abstract. These questions
cannot be answered without first knowing what will make a difference to your
customers; and the only people who know that, are customers themselves.
I could step down from the lectern and hand each of you a bunch of flowers in
the belief that doing so would be a nice gesture. Some of you may be pleased
to receive my gift. Some of you mightn’t like me very much and so may be
embarrassed by my gesture. Others still, may be catching a tram home and
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may find the flowers an unwelcomed inconvenience. Some of you may even be
offended by my gesture, seeing it as chauvinistic or sexist. And some of you
might be completely indifferent to the flowers and just leave them on the floor
at the end of the conference.
As service providers how can you know whether your customers will
appreciate the investments and projects you are proposing to undertake?
How can you know whether your proposals are going to make a difference to
them? How can you know whether you will be providing them with something
they value?
Obviously, you must ask them. You must engage them in a discussion about
the differences they seek and that you are trying to make. Alternatively stated,
you must find out whether they consider you are justified in making them pay
for whatever you are proposing to deliver.
You will need to engage with them early and on an ongoing basis. To inform
your planning processes, you will need to identify your customers’ interests,
concerns and priorities; and as you develop your plans, you will need to test
your ideas and to check whether you are still addressing the matters they
value. And then, when you have decided on your plan of action for the next
regulatory period, your price submission will need to tell this story and show
how you are (or why you are not) responding to your customers’ interests,
concerns and priorities.
These storylines will be the ‘golden threads’ that weave their way through your
submission. Done well, these story lines will coalesce into answer to the
question: What value do you deliver to your customers?
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2. Consultation is important, but it’s not the only thing that’s important.
As I’ve just explained, consultation will be of very great significance in
informing the content and presentation of pricing proposals under the new
framework. I hope I have impressed upon you the profundity of our
expectations around consultation.
As I have already made clear, we welcome the enthusiasm the industry has
shown for the proposed framework and its expectations around customer
engagement. But I must also remind you that there are other aspects of the
framework to which you will need to attend if you are to have a successful
outcome from the new regulatory process.
Please don’t forget that the framework rests upon a five-pronged assessment
requirement that involves assessing: Performance in delivering your services,
Risk management on behalf of your customers, Engagement to ensure you
understand the matters that matter most to your customers, Management
proficiency in developing your submissions, and the Outcomes to be delivered
to your customers.
Performance, Risk, Engagement, Management and Outcomes — or PREMO for
short. Every aspect of PREMO will be important when assessing an application
and no single aspect of PREMO diminishes the importance of any other aspect.
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3. Beware of confirmation bias. Be clinical.
Since we’ve been on our road trip talking to the businesses about the
framework, we’ve discovered something very interesting. Many water
authorities are telling us that they are already ambitious businesses — they’re
running efficiently, they’re consulting well with their customers, their costs and
forecasts are accurate, etc.
This reminds me of a snap poll I ran a few years ago at this forum. I asked the
gathered leaders of the water businesses to answer a simple question by a
show of hands. The questions was: “Taking everything into account, how
would you rate your overall performance as a water business?”
In response, about 90 per cent of the audience rated their performance as
either ‘excellent’ or ‘above average’. Clearly, that is mathematically
implausible or maybe impossible. I won’t repeat that exercise today, especially
now that I’ve ruined the punch line, but I will share some other interesting
observations with you.
In light of the feedback that we’ve been hearing from the businesses about
their present state of ambition, we thought we’d ask customers what they
thought about their local water business.
We engaged a professional firm which surveyed over 2,000 people, covering
customers from every retail water business across the State. We’re just writing
up the results and we’ll share them with you soon. In the meantime, Figure 1
provides a quick snapshot of what your customers had to say about you.
These results are very interesting and you will no doubt form your own views
about what they tell us.
I am not surprised by the middling finding (6/10) about the affordability of
water. After all, water bills more-or-less doubled over the last ten years.
I am, however, quite surprised that customers hold significant reservations
about the quality of their water. Seven out of ten (7/10) is hardly a ringing
endorsement.
And for today’s purpose maybe the most interesting finding is that…
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Customers’ views about the value for money they’re getting (5.9/10)
suggests that there is quite a gulf between customers’ views and the views
held by people in the industry. People in the businesses may think they’re
already ambitious. Their customers don’t appear to agree.
FIGURE 1: Customer Perceptions of their water business
Psychologists and behavioural economists warn us about something called
‘confirmation bias’ — that is, seeing what you want to see because you’ve
already made up your mind beforehand. As noted in Box 1, confirmation bias
can contribute to overconfidence in personal beliefs and can maintain or
strengthen beliefs in the face of contrary evidence.
So there is a clear message from all of this: If you have already determined in
your own mind that you are an ambitious business, then when it comes time
for assessing your submission ahead of submitting it to the regulator, you may
be lulled into a biased perception about the true level of ambition of that
submission. If you have already made up your mind about your level of
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ambition, you may not be able to apply a sufficiently clinical and analytical eye
when assessing the submission before you.
Under the PREMO framework, businesses must self-assess their price
submissions. The regulator then conducts its independent assessment. The
best outcome for a business arises when the two assessment align.
I can assure you, the Commission will be completely clinical in its assessment
of pricing proposals. I urge you to be similarly clinical. Therefore, when it
comes time to self-assessing your price submission, please do what you can to
set aside any preconceived ideas you may have about how impressive you are
as a business.
Box 1: Confirmation bias In psychology and behavioural economics, a confirmation bias describes the tendency for individuals to search for, interpret or recall information in a way that confirms their prior beliefs or hypothesis. It also suggests that people will tend to interpret ambiguous evidence as supporting their existing position. Explanations for these observed biases include wishful thinking and the limited human capacity to process information. Another explanation suggests that people show confirmation bias because they are more concerned about the costs of being wrong than they are about conducting their analysis in a neutral, scientific way. Confirmation biases contribute to overconfidence in personal beliefs and can maintain or strengthen beliefs in the face of contrary evidence. Experiments have found repeatedly that people tend to test hypotheses in a one-sided way, by searching for evidence consistent with their current hypothesis. Rather than searching through all the relevant evidence, they phrase questions to receive an affirmative answer that supports their hypothesis. They look for the consequences that they would expect if their hypothesis were true, rather than what would happen if it were false.
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4. PREMO assesses your application, not your business.
In our discussions with the businesses so far, there seems to be some
misunderstanding about the purpose of the assessment framework.
The PREMO assessment framework is designed and intended to assess your
pricing proposals and only your pricing proposals. As we’ve been travelling
around the State, we’ve heard comments that suggest that our framework will
be used to assess each business as a whole. Statements like, “We are already
an ambitious or leading business,” clearly miss the point.
While I fully understand and admire the sentiment of such statements, I need
to be absolutely unequivocal about how such statements represent a
fundamental misunderstanding about the PREMO model.
When a business uses the term “ambitious” in this context, it is very different
from the one intended in our model. When we refer to ambition, we are only
talking about the quality and scope of your pricing submission. When we refer
to ambition, it has nothing to do with other aspects of your business that might
be important to you as members of the Board or management. For example,
you may have ambitions for your organisational culture, or for your reputation,
or for the impact you have on your community or on the environment.
These ambitions are important and legitimate for you as you seek to create a
business that fulfils your expectations and the expectations of your owner.
However, these ambitions are of no interest to us as the price regulator. And
nor should they be. We have no role in the management or governance of your
businesses; and we have no interest in assuming such a role.
For us, it all comes down to your pricing proposal and the ambition shown in
that pricing proposal. The PREMO assessment framework focusses exclusively
on what you are delivering to your customer; why you are delivering it to your
customers; and at what cost to your customers. As Directors and managers,
you may hold a broader suite of ambitions. That’s for you to decide but please
be mindful not to confuse what you mean by ambition with what we mean
when we talk about ambition.
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5. We’re not interested in a marketing pitch.
Under the PREMO framework, it all comes down to your self-assessment and
then our independent assessment of your proposal. All the other ambitions to
which your business aspires won’t be relevant to our assessment framework
unless they have a direct bearing on your pricing submission. I apologise in
advance, but I am going to make this point as bluntly as I can.
Spare us your marketing pitch when drafting your self-assessments.
As I hope is becoming clear, as the price regulator we are not particularly
interested in whether you are a good or great, impressive or cutting-edge
business. We don’t assess you as a business now and we won’t be assessing
you as a business in the future. We don’t assess you. We only assess your
applications to us.
Under the PREMO model, those applications will consist of your pricing
proposal and your self-assessment of that pricing proposal. That self-
assessment will be guided by the assessment framework we are currently
developing and which will form part of the guidance material we release later
in the year. The assessment framework pertains only to your pricing
submission. It won’t be asking you to assess your business and it won’t be
asking you to tell us what sort of business you are (or to which you aspire).
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6. Your level of ambition cannot be pre-determined. It can only be derived.
Another interesting response we are hearing in our discussions with the sector
is along the lines of, “What if our customers are happy with us being standard
and don’t want to pay for ambitious or leading outcomes?”
Again, while we appreciate the sentiments in these statements, they don’t
reflect how the framework will operate.
It would be wrong, and it would be a waste of your time and effort, to think
that you could target a level of ambition under the PREMO framework at the
start of you planning processes. PREMO is not a targeting mechanism; it is an
assessment framework. Under PREMO, the level of ambition is something that
is derived after you have prepared your price submission.
It makes no sense trying to pre-determine the level of ambition you should
pursue because your proposal will be framed by your discussion with
customers about the services they want you to deliver and at what price?
Then, as a business, you must decide how you will deliver those outcomes. It is
those decisions and not the assessment framework that will determine the
content of your price submissions.
The PREMO framework and its assessment of ambition only kicks in after
you’ve identified the outcomes you will deliver and after you’ve considered
how you are going to deliver them (that is, how efficiently you will operate as a
business). The PREMO model is an assessment framework and you can only
assess the ambition of a proposal when you have a proposal to assess.
Having undertaken an assessment of your proposal, if you don’t like your
derived level of ambition, you really only have one option. The only way for
you to increase your level of ambition will be for you to deliver the same
outcomes but at more efficient cost. That will be a decision for the businesses,
not the regulator. You determine whether you want to pursue those greater
efficiencies in pursuit of a more ambitious rating. As I’ve said, a central
objective of the framework is to provide greater autonomy to the water
businesses.
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7. Your application must be your best and final offer.
There’s another misconception floating around, namely, that somehow the
framework will involve the Commission exercising a subjective view about
whether you should be doing the things you propose to be doing in your
pricing submission. Let me be very clear about this.
We’re not going to be telling you what you should be doing and nor are we
going to be telling you how you should be doing it. Under the new framework
each business will determine and then self-assess its own ‘what’ and ‘how’.
Our role we will be to independently review whether those assessments are
realistic.
In other words, when it comes to what you are proposing to do, we will be
looking to assess how openly and honestly you have determined these things
with your customers (of course, that assumes you are operating in accordance
with your governing statutes and other regulatory obligations).
When it comes to looking at how you deliver these things, we will be looking to
assess how accurately and reliably and honestly you have assessed your level
of efficiency against what could be done to maintain costs to their lowest
sustainable level.
I’ll restate those last two observations as they lie at the very crux of the new
framework and you must appreciate their importance.
When it comes to what you are proposing to do, our assessment will focus on
how openly and honestly you have determined these things with your
customers. When it comes to looking at how you deliver these things, our
assessment will focus on how accurately and reliably and honestly you have
assessed your level of efficiency.
I won’t restate those observation for a third time, but I draw your attention to
the one adverb that was used in reference to both your assessment of what
you do and your assessment of how you do it. That adverb was, “honestly”.
As I highlighted earlier, one of our objectives in setting up the framework has
been to promote business ‘autonomy’ and one of the mechanisms we use to
achieve our objectives is ‘accountability’. Autonomy and accountability are, of
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course, just two sides of the same idea and within our framework, autonomy
and accountability find their expression in the expectation of ‘honesty’ —
honesty in the preparation of your price submission and honesty in how you
assess your submission. As I said earlier, “We’re not interested in a marketing
pitch” and businesses will need to be “completely clinical” in their approach.
Or to put it in terms that might resonate more clearly with business-oriented
board members: The framework requires water businesses to submit their
‘best and final offers’ to the Commission. This is an assessment framework not
a negotiation framework. So, be humble in your self-assessment and don’t be
lured into making ambit claims.
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8. ‘Best’ may not mean a rating of ‘ambitious’ (or higher).
Having introduced this notion of best (as in ‘best and final offer’), I need to be
very clear about what it means.
We will always assume that water businesses are doing their best in the
delivery of services, management of risks, care of assets, efficiency of costs and
consultation of customers — and that their price submissions reflect those
best efforts. The new framework assumes nothing less. It does, however,
introduce an assessment framework for the ‘ambition’ of those proposals.
It is important to realise that the framework assumes no correlation between
best effort by a business and the ambition rating of a price submission. Effort
and rating are two completely separate matters. A ‘best effort’ may or may not
translate into a rating of ‘ambitious’ or ‘leading’ under the PREMO framework.
Every business is expected to submit its best effort, but how each proposal
rates under the PREMO framework remains to be seen.
Or to put this another way: A ‘standard’ proposal presumes no less effort on
behalf of the board and management team than an ‘ambitious’ proposal; and
an ‘ambitious’ proposal presumes no less effort than a ‘leading’ proposal.
Whatever the rating, the business should always be able to say it has done its
best in preparing its submission.
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9. A standard submission is not inferior to an ambitious one.
And here I need to offer a confession.
I partly regret the way we introduced terms like standard, ambitious and
leading into the assessment framework.
Originally, I suggested a simple A, B, C and D scale but the team told me it
sounded too school-like. So then I thought we could use terms like: A, AA and
AAA. But that sounded too much like we were rating the business rather than
the pricing proposal.
The reason why I partly regret introducing terms such as standard, ambitious
and leading into the assessment framework is that they sound judgemental.
That is, these terms can give the impression that a standard submission is
inferior to an ambitious submission. That was never our intention.
A standard submission is not inferior to an ambitious submission.
There’s nothing wrong or inferior about a standard submission. A standard
submission is not deficient in any way. A standard assessment means you’re
delivering services broadly in line with what you’ve delivered in the past, and
you’re doing so with little disruption to your cost structures. It’s business as
usual; and because it’s business as usual, the rate of return earned under the
framework would be broadly the same as the rate that would have been
earned under the old model. As a business you’re not proposing to change
much in the next regulatory period; what your customers receive won’t change
much; and therefore what you earn won’t change much. In future regulatory
periods, you might propose a different outcome.
Again, I repeat: We never intended to give the impression that a standard
submission was inferior to an ambitious submission. The framework is
intended to recognise that a business that seeks to deliver greater value for
money ought to have that ambition recognised financially — just as occurs
everywhere else in the economy.
Perhaps when we release the guidance material later in this year, we should
abandon the labels of standard, ambitious and leading. Maybe it would be
safer just to use terms such as ‘Level 1 Submission’, ‘Level 2 Submission’, etc.
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10. We will not be “marking to the curve”.
When I was at school a very long time ago, we used to hear about examiners
“marking to the curve”. That meant that only a certain proportion of students
would ever be awarded an ‘A’ grade, a somewhat larger proportion would
attain a ‘B’ grading, and so forth; and a predetermined proportion of students
would definitely be failed.
As we’ve been presenting our roadshow around the State, we’ve heard
comments suggesting that in applying the framework, the Commission will be
doing something similar.
Let me categorically disavow you of any such ideas.
We have no predetermined view about how many businesses should fall into
each assessment category. We will not be force fitting our assessments to
produce some predetermined distribution of outcomes. We will not be
“marking to the curve”.
Under the model, each business will assess itself and it will do so without
knowing how other businesses have assessed themselves. Our independent
review will then assess whether the businesses’ self-assessments are accurate,
reliable and honest. Presuming the businesses’ self-assessments are indeed
accurate, reliable and honest implies that the businesses, and not the
Commission, will determine the shape of the ‘curve’.
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11. The assessment framework will be as objective as possible, but no more.
As you would appreciate by now, the framework is predicated on businesses
assessing their own price submissions and then the Commission undertaking
its own independent assessment. When our respective assessments align, the
outcome will be straightforward: the business gets what it sought with little or
no change.
Of course, this core design feature — namely, the alignment of the businesses’
and the regulator’s assessments — means that we must make clear to you,
well in advance, the matters we will be taking into account when assessing
your applications. We need to make those matters as clear as possible. We
need to make them as objective as possible. And we will do so well in advance.
But there are limits.
While the assessment framework will be as objective as possible, we cannot
allow self-assessment to become a mere ‘tick-the-box’ exercise. Experience
shows that a ‘tick-the-box’ approach tends to over-compensate mediocrity and
it does not provide strong incentives for ambition.
Nor will the guidance material represent a set of minimum standards. In the
new framework there is no minimum, just as there is no maximum. It would
make no sense to frame ambition as something that was bounded by a
minimum or maximum. Ambition is, what it is.
Concerns have been raised with us that the Commission, in undertaking its
assessment of pricing submission, may use measures of ‘relative’ performance
— that is, we compare businesses to see where each one sits on a spectrum in
comparison to its peers. These concerns stem from a perceived inequity about
the Commission using measures that are not accessible to the individual
businesses when assessing their own proposals.
In response to these concerns, I’ll make one observation and I’ll give you one
assurance.
My observation is this: In the commercial world, business decisions are often
heavily dependent on relative performance and it’s up to each business to try
and foreshadow where it sits relative to its competitors. Competing with
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competitors who are partially unseen is the normal way of business. Nor is it
unfamiliar to the Victorian water industry. The principle of “competition by
comparison” is well established. It has been in practice for 20 years in Victoria.
There is no logical reason for our framework to ignore relative performance.
As to my promised assurance…
I give you my assurance that no business will have its assessment down-graded
just because it performs relatively less well than its peers. But I’ll also state the
obvious. Where we see a business performing poorly relative to its peers
without any obvious explanation, that poor performance will inform how we
look at that business. It will also raise questions in our minds about how
critically that business has assessed its own price submission. That’s not too
different from what happens now when regulators use benchmarks and cost
indices to scrutinise business proposals.
So to summarise this key message: We will be as objective as possible in the
design and conduct of the assessment framework, but not to the point where
the objectives of the new framework are denigrated. That means outcomes
under the framework won’t be perfectly certain. They can’t be. But remember
this: The Commission is obliged to make a draft decision. That means
businesses facing a rating downgrade will always have the opportunity to
contest the Commission’s assessment before a final decision is reached.
This is not a “gotcha framework”. We are not trying to “catch out” businesses
and we are not trying to embarrass businesses. We are seeking to recognise
ambition and we are trying to promote accurate and reliable submissions, and
accurate and honest self-assessments.
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12. Don't wait. Start yesterday.
And my final key message is this: You should have already started.
Some businesses have been telling us that they can’t start engaging with
customers until they see our assessment framework in order to know how that
engagement will be assessed. Simply put: That view is wrong.
There has been no wavering in our message from day one (and even earlier)
that future price submissions will need to be properly informed by customers’
interests, concerns and priorities. All businesses should be familiar with our
long-held messages around broader, earlier and deeper consultation.
There has been no material resistance from the industry to the proposed role
of customer engagement in the new framework— in fact, the contrary has
been true. The water businesses have often been the strongest advocates of
greater regulatory obligations around customer engagement; as has the
Government in its draft Water Plan.
You should be engaging with your customers already. You should be engaging
with your customers because it is the right thing to do. You should not be
engaging them just because it will now be an obligation under the PREMO
framework.
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CONCLUSION: Consultation is a process. Engagement is way of thinking.
There has been enormous interest in our work. That interest comes not just
from the local water industry or just from Victoria; it comes from interstate
and it comes from other industries and even from overseas.
The support coming from the Victorian water industry for our proposed
framework has been fantastic. We greatly appreciate the interest and
enthusiasm shown by our colleagues across the sector.
The framework responds favourably to the positions advocated over many
years by members of the water industry. It moves price regulation away from a
one-size-fits-all approach. It establishes flexible administrative processes. It
provides stronger outcome- and performance-based incentives. It promotes
efficiency and it supports and rewards meaningful customer engagement.
Importantly, the framework recognises that customer consultation is not an
end in itself.
Consultation is a process. Engagement is way of thinking. Consultation is a
process involving customers. Engagement is way of thinking about customers.
Under the framework, price submissions will be presented as a story about
customers and the outcomes from which they will benefit. As our team back in
the office would say, this is the “golden thread” that ties together your
projects, expenditures and tariffs. It is these golden threads that will finally
answer the question I asked the water industry a few years ago: “What value
do you deliver to your customers?”
— END —
