Insights

UK water social contract: A rising opportunity to optimise for both social and business value

Water company executives will currently be scratching their heads trying to figure out how they can best deliver on their AMP7 business plans considering the massive cost challenge set by Ofwat.
At the same time, given a rising social agenda in the sector and calls to do more for society and the environment, they will also be asking themselves some broader, fundamental questions about their purpose and what their holistic impact should be in the long term.

A drop of watter rippling

In the past, delivering cost efficiency and greater social value may have been viewed as a trade-off –research shows that until recently many corporate leaders believed that pursuing a sustainability agenda ran counter to the wishes of shareholders.[1] This view has shifted in recent years as evidence now shows that when done properly, incorporating social values into organisations can in fact drive greater business value over the long term.

CEO of the UK water regulator (Ofwat), Rachel Fletcher, highlighted this shift in a recent speech encouraging the adoption of greater social purpose in the UK water sector.[2] When presenting the social value business case, she quoted Larry Fink, founder and CEO of BlackRock, when he said:

"Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate."

The message is clear, any company (not only water companies) that wants to survive over the long term needs to be driven by more than the just profit. Fittingly, BlackRock, the world’s largest asset manager, owns sizable shares in all three FTSE listed UK water companies – Severn Trent, United Utilities and South West Water – perhaps strengthening the pertinence of the narrative to the UK water sector.

The rise of the social contract

As regulated providers of an essential public service, UK water companies already declare that they place customers and the environment at the core of what they do. But the reality is that some have fallen short in recent years and as a result the entire sector’s reputation has come under increased scrutiny.

Big questions have been raised around the way our private water companies run their businesses with many arguing that the industry has failed on the promised benefits of privatisation, profiting shareholders and executives at the expense of society and the environment.

In the wake of these questions (and growing support for Labour Party’s calls for re-nationalisation), Ofwat has recently been stepping up its challenge to companies to do more in owning their public purpose and incorporating social and environmental values into their organisations.[3] As it stands, Ofwat is hesitant to take any enforcing action outside of its current regulatory framework but is rather looking at companies to take the lead in establishing their own “social contract” or framework to deliver their social purpose.

Sceptics argue that without licence changes or explicit incentives, there is a risk that the concept of a social contract may merely end up becoming a company PR exercise without any truly meaningful actions or measurable benefits beyond current obligations. This is a fair argument, writing down a new social mission on a piece of paper doesn’t mean much unless it is truly bought into, embedded and acted upon.

On the more optimistic side, others believe that the industry has recognised the need for change and is embracing the need to and value of doing more in the face of challenges such as climate change and population growth. Industry trade association, Water UK’s publication of Public Interest Commitments for the sector is viewed as early evidence that the case for progressive change is being recognised.[4]

Regardless of which side you are on, what’s clear is that the social contract is not going away any time soon. Given Ofwat’s current light touch approach, the success will largely depend on the companies. As we approach AMP7, there is a need for fresh thinking to meet new challenges – perhaps the business case for the social contract fits into this category.

With that in mind, below we share some thoughts on how companies should look to optimise their social contract to deliver both social and business value.

Co-define purpose with customers and community

A key aspect of the social contract is about bringing customers and communities along on the journey. For this to happen, companies should work with their local stakeholders and customers to co-define a clear social purpose that the public understands and can buy into.

This may seem obvious, but the value of doing this first step well is often underestimated.

As regulated monopolies, water companies are already required to undertake extensive stakeholder engagement in justifying their business plans and actions. When establishing a social contract, the significance of having a robust stakeholder engagement framework in place is arguably more important than ever.

Companies need to go a step further than their PR19 business plans in clearly communicating the future challenges being faced and how all need to work together in mitigating them. This requires tailored engagement to the right stakeholders and a process with clear feedback loops leading to actions.

By co-defining their social purpose with stakeholders, companies will ensure they are setting the right mission and position themselves to deliver not only societal but also shareholder benefit beyond the intrinsic value of the service they are providing.

Embed social value in the business model

There is comprehensive evidence to suggest that incorporating social value into the legal structure of a business fundamentally changes the way the organisation thinks and acts.[5]

Anglian Water recently announced that it had become the first UK water company to amend its Articles of Association to enshrine public interest outcomes for society and the environment.[6] The change means the company now has a legal obligation to take account of its impact on customers, communities and the environment while balancing the interests of its shareholders.

While the action by Anglian has been applauded across the industry, it is widely acknowledged that no company is identical and making constitutional changes isn’t necessarily the only way to do things – there isn’t a one size fits all model. Irrespective of the route companies decide to take, what is more important is how they behave and deliver on what they have defined as their social purpose.

Getting this right starts with company leadership and clear messaging from the board.

social principles shouldn’t sit in one end of the company but should come from the top and be integrated throughout. For some, this will require a rethinking of old business models in order to set up for success.

One example of new thinking that has been gaining currency in the sector is the concept of the “six capitals” (financial, manufactured, human, intellectual, social, natural) or sustainability accounting, with many water companies already beginning to incorporate this into their decision-making frameworks.
In order to be effective, models like the six capitals need to be supported by an ongoing internal dialogue until a culture of innovative thinking and doing the “right thing” becomes business as usual. Armed with purpose, companies should be able to attract new talent with ambition to work in an environment where they can contribute to society and tackle big challenges – an attractive prospect to an industry facing an aging workforce.

Make it measurable and be held accountable

Once social purpose is defined and embedded a critical question remains – how will it all be measured and how will companies be held accountable for delivery?

There are several different schemes that make a start at measuring social value such as ESG (environmental, social, governance) metrics, British Standard Institutes standards, BITCs responsible business tracker and the six capitals methodology mentioned previously. Without a standard regulatory requirement, it is up to the companies to decide how they keep score and report.

In deciding this, once again they should ask the question to customers. A useful tool to support this process is the social return on investment (SROI) method, which has been adopted by several energy networks in their business planning process, whereby companies are able to measure social and environmental factors in financial terms allowing a quantifiable comparison of total economic value across initiatives.

Regardless of the tools or metrics used, companies should aim to keep it simple, consistent and transparent. The framework should clearly demonstrate the value of the initiatives being delivered and how they measure up against their targets on an ongoing basis.

On the question of accountability, attaching financial consequences or incentives (beyond regulatory ODIs) is an intuitive example of how companies can demonstrate that they are taking the social contract seriously by having skin in the game. Several water and energy utilities already tie executive pay to social outcomes, but the social contract could offer an opportunity for water companies to incorporate these incentives in a more holistic way.

Incentivising employees to act in the interest of the public and environment not only encourages the right behaviour but sends a clear message and makes a positive stride towards building trust – social commitments are more believable if failing to deliver on them results in direct financial consequences to those responsible for their delivery. If executives are confident that they represent a purpose driven organisation and design a social contract that leads to sustainable value creation, they should have no issue attaching financial incentives – in fact, this should be embraced.

Conclusion

Entering AMP7 there are new challenges for companies but also new opportunities to deliver for the environment, customers and shareholders in a rounded way. Regaining trust does not happen overnight and while the social contract is a good reset point, the true value will be measured by how companies are able to turn their positive objectives into tangible results.

Those who are proactive and look at deeply embedding social purpose now should view it as a chance to not only reshape the way industry approaches this issue, but also as an opportunity to position themselves to create sustainable value over the long term.

[1] https://hbr.org/2019/05/the-investor-revolution

[2] https://www.ofwat.gov.uk/wp-content/uploads/2018/11/Speech-from-Rachel-Fletcher-A-social-contract-for-the-water-sector.pdf

[3] https://www.ofwat.gov.uk/wp-content/uploads/2019/05/Ofwats-emerging-strategy-Join-the-conversation.pdf

[4] https://www.thewaterreport.co.uk/stories-c1inc

[5] https://www.youtube.com/watch?v=dkSbWJPfNpY&utm_source=LinkedIn&utm_medium=social&utm_campaign=SocialSignIn&utm_content=Vision+and+Strategy

[6] https://www.anglianwater.co.uk/news/anglian-water-becomes-first-water-company-to-embed-public-interest-at-its-core/