Developing panel based methods for profit and performance measurement in the water and sewage sector in England and Wales

Abstract

The aim of the thesis is to evaluate the impact of regulatory price cap schemes on the financial performance of the Water and Sewerage Companies (WaSCs) even when the number of observations is small. We applied an index number approach to allow for cross sectional comparisons of relative profitability, productivity and price performance of WaSCs during the years 1991-2008. We also applied a panel index approach across WaSCs over time to decompose unit-specific (temporal) index number based profitability growth as a function of the profitability, productivity andprice performance growth achieved by benchmark firms, and the catch-up to the benchmark firm achieved by less productive firms. We also employed both index numbers and DEA techniques to evaluate various profit drivers such as price changes, productivity changes and activity effect levels on the financial performance of WaSCs over time. Exogenous characteristics like water and sewerage quality were also included in a profit decomposition analysis. The results showed that during 1991-2000 price caps were “weak” as prices were high enough for the firms to achieveeconomic profits despite their low productivity levels. However, after 2000 prices became “catch up promoting” as they required less productive companies to eliminate at least some excess costs in order to eliminate economic losses. The steady decline in average price performance, gains in productivity and relatively stable economicprofitability after 2000, suggest that Ofwat is now more focused on passing productivity benefits to consumers, and maintaining stable profitability than it was in earlier regulatory periods. The positive impact on profit changes came from substantial improvements in technical change, the cost efficient allocation of resources by substituting labour with capital and small improvements in efficiencygains and output mix. The input price and scale effect had a significant negative impact on profit changes. We suggest that our approach should be of great interest to researchers who are interested in evaluating the effectiveness of regulation and/or developing effective comparative performance techniques when sample sizes arelimited.