performance, risk and strategy in privatised, regulated industries the uk’s experience

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Performance, risk and strategy

in privatised, regulatedindustriesThe UK’s experience

David Parker Aston Business School, Aston University, Birmingham, UK

Keywords Privatization, Regulations, Public utilities, United Kingdom

Abstract Internationally public utilities, sometimes referred to as network industries, are being privatised and dedicated regulatory structures to protect the public interest are being introduced.

This study looks at the related issues of post-privatisation performance, regulatory risk and management strategies in privatised public utilities, drawing on evidence from the UK. The main

findings are, first, that in assessing the impact of privatisation on economic performance it isdifficult to separate out the effects of ownership, competition, regulation and technological change.Second, that in terms of the distribution of the efficiency gains, initially investors were the mainbeneficiaries in the UK, but consumers gained as competition developed and regulation tightened.Third, regulated enterprises are subject to regulatory risk as well as commercial risk withimplications for types of management strategies adopted. Following privatisation the dynamics of regulation involve both the regulator and management learning about regulation and the optimal

strategies to adopt. The UK’s experiences are educational for those countries now contemplating or in the process of introducing privatisation programmes.

Introduction

The public utilities, namely gas, electricity, water and sewerage,telecommunications and public transport developed mainly as a combinationof private and municipal functions in the nineteenth century. The twentiethcentury, however, and particularly the years immediately after the SecondWorld War saw large-scale nationalisation. Therefore for most of the last 50years state ownership has been the dominant mode of organising anddelivering utility services.

In the 1980s this began to change. This was because of growing discontentwith the efficiency of service delivery in the public sector (Aharoni, 1986) andbecause technological change was creating opportunities for competition in

supply where previously monopoly was expected to lead to the lowest costs of production. For example, combined cycle gas turbine generating setssignificantly reduced the optimal scale in electricity generation enablingmore firms to compete. In telecommunications new optical fibre and cellulartechnologies enhanced the scope for competition in that industry. All of thiswas occurring at a time when governments faced budgetary pressures and,more recently in Europe, limits on government borrowing laid down by theMaastricht Agreement, in the run up to the establishment of a common

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Performance,risk and strategy

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The International Journal of PublicSector ManagementVol. 16 No. 1, 2003

pp. 75-100q MCB UP Limited

0951-3558DOI 10.1108/09513550310456436



European currency. Governments have turned to restructuring and privatisingtheir utility industries so as to curtail state subsidies. European CommissionDirectives aimed at liberalising markets, initially in telecommunications andelectricity but now also in gas and railways, have added further impetus (for amore detailed discussion see Parker, 1998). In developing countriesprivatisations in the utilities sector have accounted for over one-third of all privatisation transactions since 1988 (Cook and Uchida, 2001, p. 2). Theprivatisation of public utilities is also occurring in the transition economies of central and eastern Europe.

The UK has taken the lead in utility privatisation. The first major utility tobe sold in the UK was British Telecom (BT), in 1984, a sell-off that attracted asurprising amount of City and public interest in the stock. This was followedby the privatisation of British Gas in 1986, the water and sewerage industry in1989, electricity in 1990/1991, and the railways between 1995 and 1997. Coach

and local bus transport in the UK was privatised during the 1980s. With thenotable exception of the latter, which was structured as a competitive industry,privatisation led to the establishment of dedicated regulatory offices to protectconsumers from monopoly abuse until competition arrived. These regulatoryoffices are the Office of Telecommunications (OFTEL), the Gas and ElectricityMarkets Authority (GEMA), the Office of Water Services (OFWAT), the Officeof Rail Regulation (ORR) and the Strategic Rail Authority (SRA).

The UK example has provided impetus for privatisation in other parts of Europe. Privatisation grew in importance in the 1990s with large-scaleprogrammes in Italy, Portugal, France and Spain in particular. Alongsideprivatisation, new regulatory offices have been established, in part modelled on

those in the UK and in the main part to some degree at arm’s length from thegovernment department that previously regulated the state-owned firms. Thishas been encouraged in the electricity and telecommunications sectors byEuropean Commission market-liberalisation directives. Transparent regulationof prices, including the terms on which new competitors can access the networkof incumbent operators, is important if there is to be a “level playing field” sothat competition can develop.

The aim of this paper is to review the record of public utility privatisation inthe UK, especially in terms of economic performance, regulation andmanagement strategies in the industries. First, the performance of the

privatised utilities in the UK is considered in the light of claims about thebenefits of privatisation. Second, the discussion turns to the subject of regulation and regulatory risk, before looking at the implications of privatisation, market liberalisation and regulation for the strategies of utilityenterprises. The paper concludes with a summary of the main points raised andthat are relevant wherever utilities are privatised as regulated businesses. Insummary the paper argues that it is difficult to separate out the individualcontributions of ownership change, competition, regulation and technological

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change in improving organisational performance; that minimising regulatoryrisk while achieving regulatory goals is complex; and that after privatisationbusiness success necessitates a fundamental review of strategy and operations.The UK’s experiences should prove useful for those countries contemplating orin the process of introducing privatisation programmes.

Privatisation and performanceThe case for privatisation is based on arguments from economics that stressthe superiority of private over public ownership in terms of capital and productmarket incentives (Vickers and Yarrow, 1988; Bos, 1991; Boycko et al., 1996).The efficiency gains are expected to be in allocative efficiency, as prices aremore closely related to long-run marginal costs of supply and technicalefficiency, as costs of production are minimised. However, those advocatingprivatisation often couch the discussion as a choice between monopoly state

ownership and competitive private markets. In utility sectors the real choice,especially in the early years after privatisation, is normally between statemonopolies and private monopolies or at least firms that remain dominant intheir markets for some time (e.g. after 15 years of privatisation British Telecomstill had around 76 per cent of the overall telecoms market in the UK).

In a monopoly environment the distribution of efficiency gains betweeneconomic rents to producers (“producer surplus”) and lower prices andimproved services to consumers (“consumer surplus”) relies heavily on theeffectiveness of the “regulator”. Regulation becomes a form of proxycompetition, with the regulator attempting to achieve allocative andtechnical efficiency in the industry in the absence of competition. Also, theform of the regulation can be crucial. For example, it can be shown that undercost of service regulation, where prices are adjusted based on allowed costs andan agreed profit, a publicly-owned utility, under pressure from government tominimise the burden on taxpayers, may pursue efficiency gains morevigorously than an equivalent private sector company. The private sectorcompany passes cost increases on to consumers in the form of higher priceswith no impact on its profits. This is consistent with de Fraja’s (1993)suggestion that under certain regulatory conditions the public sector may bemore efficient than privatised, regulated businesses. Much therefore turns onthe interaction between the regulatory system and the structure of property

rights for management incentives and disincentives.State ownership is associated with day-to-day intervention by ministers andcivil servants in the management of enterprises, for example determiningprices, investments and employment levels. Privatisation with effectiveregulation is intended to alter the state’s role to establishing the regulatoryframework or “the rules of the game”. Private sector management thenmanages its enterprises within the regulatory rules. This leads to a change inthe operating environment for the management of the utilities. Previously they


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were accountable to government and subject to final decisions being madepolitically. Now privatised, the management are accountable to newstakeholders in the form of shareholders and private loan creditors (thecapital market) and the new regulatory agencies. They may also face a moredynamic and hostile competitive market for their outputs. This can be expectedto have a profound effect on management orientation, structures and processes,as discussed in more detail later.

The expectation, therefore, is that privatisation can lead to importantefficiency gains but that the roles of competition and regulation are crucial. Inthe UK a number of studies have been undertaken into the effects of privatisation on performance, but it has proved problematic to separate out theeffects of ownership, competition, regulation and technological change.Therefore it remains unclear how far privatisation rather than other factors isresponsible for the efficiency gains. According to some commentators (e.g.

Millward and Parker, 1983; Kay and Thompson, 1986; Vickers and Yarrow,1988) competition is likely to be more important than ownership, althougharguably without privatisation competition could not fully develop. Table Iprovides a summary of a number of different UK studies of the effects of privatisation on performance including those relating to public utilities. It isclear that some have found that privatisation has not led to an obvious changein economic performance. In a number of cases performance improvementsrecorded continue a trend that pre-dates privatisation. One explanation of themixed results is as follows:

. The greatest scope for efficiency gains occurs in the utility industrieswhere previously monopoly suppliers existed. Where state industriesoperate in competitive markets there is less scope for management tomake large efficiency gains after privatisation. Presumably enterprisesmust have already been reasonably efficient to have survived in acompetitive market, at least in the absence of continued state subsidies.

. Competition and regulation are important in providing the necessaryincentives for management to seek out efficiency gains followingprivatisation. Therefore until competition and regulation significantlyimpact efficiency gains will be limited.

These arguments are supported, for example, by the comprehensive study of

UK privatisation in Martin and Parker (1997). In this study, which revealed noconsistent relationship between ownership and performance, a number of enterprises in competitive markets were included alongside two utilities,British Gas and BT. Labour productivity growth in BT and British Gas fellafter privatisation, although it recovered sharply later. In both cases at first theregulatory pressures (including the price caps) provided generous scope toraise profits without major cost cutting. Also, competition did not begin toimpact significantly until restrictions on market entry were gradually removed

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A u t h o r ( s )

I n d u s t r y ( s )

M a i n p e r f o r m a n

c e

m e a s u r e s u s e d

F i n d i n g s

H u t c h i n s o n ( 1 9 9 1 )

1 7 U K fi r m s i n s e v e r a l

i n d u s t r i a l

g r o u p i n g s

L a b o u r p r o d u c t i v i t y ,

p r o fi t a b i l i t y a n d

t e c h n o l o g y m i x

P r i v a t e l y - o w n e d fi r m s o u t p e r

f o r m e d

c o m p a r a b l e s t a t e - o w n e d fi r m s i n t h e

1 9 7 0 s a n d 1 9 8 0 s i n t e r m s o f p r o fi t a b i l i t y

o n l y . L e s s c e r t a i n w h e t h e r p r

i v a t i s a t i o n

h a d i m p r o v e d p e r f o r m a n c e

B i s h o p a n d T h o m p s o n ( 1 9 9 2 )

N i n e p r i v a t i s e d e n t e r p r i s e s a c r o s s a

r a n g e o f U K i n d u s t r i e s

. I n c l u d e s B T ,

B r i t i s h G a s a n d e l e c t r i c i t y s u p p l y

L a b o u r p r o d u c t i v i t y

a n d T F P , 1 9 7 0 - 1 9 8 0

c o m p a r e d w i t h

1 9 8 0 - 1 9 9 0

T h e r e w a s h i g h e r g r o w t h i n l a b o u r

p r o d u c t i v i t y i n B T b u t t h e g r o w t h i n

T F P f e l l i n t h e 1 9 8 0 s . I n B r i t i s h G a s

l a b o u r p r o d u c t i v i t y g r e w a t t h

e s a m e r a t e

i n t h e 1 9 7 0 s a s t h e 1 9 8 0 s , w h

i l e t h e

g r o w t h o f T F P d e c l i n e d . E l e c

t r i c i t y

s u p p l y s a w a f a l l i n b o t h l a b o u r

p r o d u c t i v i t y a n d T F P g r o w t h

H a s k e l a n d S z y m a n s k i ( 1 9 9 3 )

1 2 p r i v a t i s e d fi r m s b e t w e e n 1 9 7 2 a n d

1 9 8 8 , i n c l u d i n g B T , B r i t i s h G a s ,

e l e c t r i c i t y s u p p l y a n d w a t e r

E s t i m a t e s o f

p r o d u c t i v i t y g r o

w t h

( o u t p u t p e r

e m p l o y e e )

I n t h e m a i n p r o d u c t i v i t y h a s

g r o w n

f a s t e r i n t h e 1 9 8 0 s . C o m p e t i t i o n i s a

s i g n i fi c a n t c a u s a l f a c t o r

B u r n s a n d W e y m a n - J o n e s ( 1 9 9 4 )

E l e c t r i c i t y d i s t r i b u t i o n

M u l t i p l e i n p u t ,

m u l t i p l e o u t p u t

m o d e l o f b e f o r e

a n d

a f t e r p r i v a t i s a t i o n

u s i n g m a t h e m a t i c a l

p r o g r a m m i n g

t e c h n i q u e s

T h e 1 2 e l e c t r i c i t y d i s t r i b u t i o n

c o m p a n i e s

h a v e b e e n m o r e e f fi c i e n t s i n c e

p r i v a t i s a t i o n , b u t t h i s c o n t i n u

e s a l o n g -

t e r m h i s t o r i c a l t r e n d . T h e r e i s a l s o a

g r e a t e r d i v e r s i t y o f p e r f o r m a n c e

a m o n g s t t h e 1 2 s i n c e p r i v a t i s

a t i o n

( c o n t i n u e d )

Table I.UK privatisation: a

summary ofefficiency studies


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A u t h o r ( s )


M a i n p e r f o r m a n c e


F i n d i n g s

P a r k e r ( 1 9 9 4 )

B r i t i s h T e l e c o m ( B T ) 1 9 7 9 / 1 9 8 0 t o

1 9 9 3 / 1 9 9 4

P r o d u c t i v i t y a n

d

e m p l o y m e n t c o s t s i n

t o t a l c o s t s

L a b o u r p r o d u c t i v i t y g r o w n f

a s t e r s i n c e

p r i v a t i s a t i o n , b u t t h e r e c o r d f o r T F P i s

m u c h l e s s i m p r e s s i v e . E m p l o

y m e n t c o s t s

h a v e d e c l i n e d a s a p e r c e n t a g e

o f a l l c o s t s ,

c o n t i n u i n g a t r e n d t h a t d a t e s

b a c k t o

b e f o r e p r i v a t i s a t i o n

B i s h o p a n d G r e e n ( 1 9 9 5

)

S i x p r i v a t i s e d e n t e r p r i s e s i n c l u d i n g

B r i t i s h G a s a n d B T

T F P a n d fi n a n c

i a l

d a t a 1 9 8 9 - 1 9 9 4

C o m p e t i t i o n r a t h e r t h a n o w n

e r s h i p i s

i m p o r t a n t . G r o w t h i n T F P i n

B T w a s i n

p a r t d u e t o t e c h n i c a l c h a n g e

W a d d a m s P r i c e a n d W e y m a n - J o n e s

( 1 9 9 6 )

G a s i n d u s t r y , 1 9 7 7 / 1 9 7 8 t o 1 9 9 1

M a l m q u i s t i n d i c e s o f

p r o d u c t i v i t y g r o w t h

P o s t - p r i v a t i s a t i o n p r o d u c t i v i t y g r o w t h

w a s a r o u n d 5 - 6 p e r c e n t p e r

a n n u m

c o m p a r e d w i t h 3 p e r c e n t a y e a r b e f o r e

p r i v a t i s a t i o n i n 1 9 8 6 . H o w e v e r ,

d i f f e r e n c e s r e m a i n i n t e c h n i c a l e f fi c i e n c y

a m o n g B r i t i s h G a s ’ s r e g i o n s

N e w b e r y a n d P o l l i t t ( 1 9

9 7 )

E l e c t r i c i t y g e n e r a t i o n

V a r i o u s

L a b o u r p r o d u c t i v i t y h a s m o r

e t h a n

d o u b l e d s i n c e 1 9 9 0 , m a i n l y d

u e t o

s h e d d i n g l a b o u r . R e a l u n i t c o s t s h a v e

d e c l i n e d

S h a o u l ( 1 9 9 7 )

W a t e r i n d u s t r y

C o s t a n d o u t p u t d a t a G r e a t e r e f fi c i e n c y g a i n s , m e a

n i n g l o w e r

c o s t s r e l a t i v e t o o u t p u t , o c c u r r e d p r i o r t o

p r i v a t i s a t i o n

M a r t i n a n d P a r k e r ( 1 9 9 7 )

1 1 p r i v a t i s e d o r g a n i s a t i o n s s t u d i e d

i n c l u d i n g B r i t i s h G a s a n d B T . Y e a r s

b e f o r e a n d a f t e r p r i v a t i s a t i o n i n c l u d e d

L a b o u r p r o d u c t i v i t y ,

T F P , v a r i o u s

fi n a n c i a l r a t i o s

a n d

d a t a e n v e l o p m e

n t

a n a l y s i s ( D E A )

M i x e d r e s u l t s w i t h l a b o u r p r

o d u c t i v i t y

g r o w t h e v i d e n t b u t T F P g r o w t h l a g g i n g

b e h i n d

( c o n t i n u e d )

Table I.

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A u t h o r ( s )


M a i n p e r f o r m a n

c e


F i n d i n g s

O ’ M a h o n y ( 1 9 9 8 )

S e c t o r s o f U K e c o n o m y i n c l u d i n g

e l e c t r i c i t y , g a s a n d w a

t e r

L a b o u r p r o d u c t i v i t y

a n d T F P i n t h e

U K

r e l a t i v e t o U S A ,

F r a n c e , G e r m a n

y

a n d J a p a n

P r o d u c t i v i t y g a p d e c l i n e d i n

1 9 9 5

c o m p a r e d t o 1 9 8 9 ; b u t e v i d e n c e o f a

c l o s i n g g a p f r o m t h e 1 9 7 0 s e

x c e p t

r e l a t i v e t o F r a n c e

P a r k e r a n d W u ( 1 9 9 8 )

U K s t e e l i n d u s t r y c o m

p a r e d t o s t e e l

p r o d u c e r s i n s i x o t h e r

c o u n t r i e s

D E A a n a l y s i s o

f

r e l a t i v e i n p u t - o u t p u t

e f fi c i e n c y a n d

p r o d u c t i v i t y fi g

u r e s

A l a r g e i m p r o v e m e n t i n r e l a t i v e

p e r f o r m a n c e o c c u r r e d i n t h e B r i t i s h s t e e l

i n d u s t r y b e f o r e t h e p r i v a t i s a t i o n .

P r i v a t i s a t i o n w a s f o l l o w e d b y

a d e c l i n e i n

r e l a t i v e p e r f o r m a n c e

P a r k e r ( 1 9 9 9 b )

B r i t i s h A i r p o r t s A u t h o r i t y – l a r g e s t

a i r p o r t o p e r a t o r i n t h e

U K p r i v a t i s e d i n

J u l y 1 9 8 7

D E A a n a l y s i s o

f t h e

r e l a t i v e p e r f o r m

a n c e

o f B A A p r e - a n d

p o s t - p r i v a t i s a t i o n

a n d t h e r e l a t i v e

p e r f o r m a n c e o f

i t s

i n d i v i d u a l a i r p o

r t s

c o m p a r e d w i t h o t h e r

a i r p o r t s i n t h e U K

p r i v a t e l y a n d

p u b l i c l y o w n e d

N o e v i d e n c e t h a t p r i v a t i s a t i o

n h a d a

s i g n i fi c a n t e f f e c t o n p e r f o r m a n c e .

P e r f o r m a n c e i m p r o v e m e n t s w

e r e a

c o n t i n u a t i o n o f a l o n g e r - t e r m

t r e n d

S a a l a n d P a r k e r ( 2 0 0 0 , 2 0 0 1 )

T h e t e n w a t e r a n d s e w

e r a g e c o m p a n i e s

o f E n g l a n d a n d W a l e s

p r i v a t i s e d i n 1 9 8 9

P r o d u c t i v i t y a n

d

c o s t f u c t i o n a n a

l y s e s

P e r f o r m a n c e i m p r o v e m e n t s w

e r e m a i n l y

a s s o c i a t e d w i t h t h e t i g h t e r p r i c e

r e g u l a t i o n i n t r o d u c e d b y t h e

r e g u l a t o r i n

1 9 9 5 r a t h e r t h a n p r i v a t i s a t i o n p e r s e

Table I.


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during the 1990s. In the face of tightening regulation and more competition,however, productivity responded. The average annual rise in labourproductivity was around 15 per cent in BT and 6 per cent in British Gas inthe early to the mid-1990s. Since then the continued growth of competition hasspurred further productivity gains. Waddams Price and Weyman-Jones (1996)have also found evidence of higher productivity growth in British Gas sinceprivatisation.

This trend emphasising the roles of competition and regulation is also bornout by the record of the UK electricity industry. Here competition wasintroduced at privatisation and was quickly extended. Burns and Weyman- Jones (1994) in an early study concluded that the 12 regional electricitydistribution companies had become more efficient after privatisation but thiswas a continuation of a longer-term trend. A more recent review of the industryas a whole has concluded that “productivity in the industry has almost doubled

since privatisation” (Electricity Association, 1998, p. 55). Another intoelectricity generation found that substantial cost reductions had occurred,although investors rather than consumers had been the main beneficiaries(Newbery and Pollitt, 1997). In electricity like the other utility industries theefficiency increases are a reflection of the sharp reductions in employmentachieved. Employment in the industry fell from 127,300 at privatisation toaround 66,000 by 1996/1997. Over the same period transmission operatingcosts fell by nearly 40 per cent ( Financial Times, 1999a). There have also beenvery large reductions in employment in BT and British Gas and its successorcompanies. On the railways there has been a paucity of studies of performancesince privatisation, although with increasing traffic labour productivity has

almost certainly increased. However, it seems clear that the industry is in astate of crisis following the financial collapse of the infrastructure operatorRailtrack.

Turning to the water industry where there is still very little competition,Shaoul (1997) concluded that significant efficiency gains, meaning lower costsrelative to output, occurred before privatisation. Initially after privatisationemployment in the industry rose. In 1990/1991 the average number of employees in the water supply and sewerage companies was 45,863. By1993/1994 this had grown to 58,270. Since then numbers have fallen and thewater regulator’s price cap set in 1999 implied that the water companies would

need to achieve operating efficiency gains of almost 16 per cent over thefollowing five years ( Financial Times, 1999b, p. 6). What appears to havehappened in this industry is that lax regulation at the outset plus a lack of competition combined to keep efficiency incentives weak in the early years.This is borne out in the studies by Saal and Parker (2000, 2001), which foundthat efficiency improvements in the water and sewerage industry in Englandand Wales occurred mainly after regulatory tightening, in the form of a pricecap review, in 1995.

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In the case of all of the privatisations, results may well have been affected bytechnical change. This is particularly so in telecommunications and electricitygeneration where there have been some notable technological improvements, asnoted earlier. One way forward is to compare the performance of the UKutilities with those overseas and able to capitalise equally on the newtechnologies. In this respect O’Mahony’s (1998) work on comparativeproductivity levels in the electricity, gas and water sectors in the USA,France, Germany and Japan compared with the UK is of interest. It is evidentfrom the figures in this study that the labour and total factor productivity gapbetween the UK and these other countries has narrowed, but that in most casesthis narrowing dates back to the late 1970s or before. That is to say, thecatching up in productivity pre-dates privatisation, a result consistent with thefindings of a number of the studies summarised in Table I. For example, Parkerand Wu (1998) found that comparing the British steel industry with a number

of other steel industries around the world, the relative performance of BritishSteel declined after privatisation. British Steel had improved its relativeperformance in the last few years of state ownership.

O’Mahony’s study covers both labour and total factor productivity (TFP).An analysis of production efficiency should include changes in TFP. Labourproductivity gains may result from substitution of capital for labour.Calculating TFP is complex, however, requiring accurate data on capital andother inputs with TFP representing the residual output not explained by theadditional inputs. Where TFP measurement has been attempted in UKprivatisation studies the results generally suggest that the efficiency gainshave been smaller than for labour productivity (e.g. Martin and Parker, 1997).

This could well reflect the greater ease with which labour inputs are adjustedafter privatisation compared with reconfiguring capital stock; previous over-manning under state ownership; and the tendency for City investors to want tosee quick and visible evidence of cost cutting (Cox et al., 1999). It could alsosimply reflect the difficulty in calculating TFP and resulting inaccuracies in thestatistical results.

Productivity and cost studies are concerned with measuring changes inproduction efficiency. One further set of benefits from privatisation andcompetition should be greater allocative efficiency. Allocative efficiency is theextent to which prices reflect marginal costs of supply. This efficiency is

notoriously difficult to measure directly requiring considerable data on marketdemand and cost functions. But it can be estimated in terms of how far sinceprivatisation prices have been aligned with costs. Across the UK-regulatedindustries both regulation and competition have encouraged the companies toremove cross-subsidies and end price discrimination. Therefore in the formermonopoly markets prices have become more closely aligned with supply costssuggesting higher allocative efficiency. It is also the case that consumers havebenefited from efficiency gains through lower prices.


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In most of the UK-regulated industries prices have fallen since privatisationreflecting the gains in production efficiency already mentioned. The followingexamples are selected to reflect the general nature of the price changes sinceprivatisation (a more detailed account can be found in Parker, 1999a, p. 127).Taking telecommunications first, since privatisation average charges havefallen by around 40 per cent, though this change certainly results fromtechnology and competition in addition to ownership change and regulation.Turning to the gas sector, the next to be privatised after telecommunications,between 1986 and 1997 domestic gas bills fell by an average of 2.6 per cent ayear, again in real terms. More recently the introduction of competition fordomestic gas supplies has led to further cuts of up to 20 per cent. After thedomestic market was liberalised one in four domestic consumers switched fromthe former monopoly supplier, British Gas, to a new supplier.

In the electricity market the decline in charges for domestic consumers in

England and Wales in the 1990s was around 26 per cent in real terms fordomestic consumers; while the reduction for industrial and commercialconsumers was even larger, totalling between 25 per cent and 34 per cent( Financial Times, 1999a)[1]. The recent reform of wholesale pricing of electricity has led to further sharp price falls in England and Wales. The mainexception to this impressive track record on charging is in the water andsewerage industry. Here domestic charges have risen since privatisation, byover 40 per cent in real terms for average unmeasured water and sewerage bills(by less for measured or metered services). This has been in no small part dueto the need to fund investments to modernise the system after years of underinvestment in the state sector and to meet the requirements of the EU water

quality directives. But it is also likely to reflect the lack of competition in water.The water regulator has now indicated that he expects to see a future reductionin prices to consumers and the government is currently exploring ways tointroduce more competition into the industry. The ability of the water industryto raise charges in the past may well have blunted management’s incentive topursue cost cutting in this industry to the same extent as found intelecommunications, gas and electricity.

Service quality improvements are particularly difficult to summarisebecause service quality is multi-dimensional. Nevertheless, there is no evidencethat lower manning and price reductions have been at the expense of service

quality, even though this is always a potential danger under a price cap systemof regulation where management is incentivised to cut costs. Indeed, there isevidence of an improved quality of service since privatisation across the utilitysectors with the obvious exception of the railways, where service failures occuron a regular a basis (for a review see Parker, 1998a). Space precludes a detailedanalysis of service measures here; but suffice to say that in all of the regulatedindustries, including the railways, the regulators have negotiated serviceperformance standards with the companies and penalties and compensation

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payments to consumers for service failures. Over the years the regulators haveset more exacting service standards that have delivered service improvements.

In summary and notwithstanding some of the findings summarised inTable I, the UK’s experience does suggest that for those industries previouslypopulated by monopoly state enterprises privatisation has been associatedwith efficiency gains. This in turn has led to benefits to consumers in terms of lower prices, except in water, and improved services, except so far on therailways. More problematic is to know to what extent such improvementsresult from privatisation or from regulation and competition or from otherfactors notably technological change and changes in input prices (e.g. fuelcosts). A number of the studies noted in Table I were unable to reject the nullhypothesis that ownership has no effect on performance, although this maysimply reflect the difficult of separating out ownership from other causes. Onerecent study has suggested that price reductions in electricity would have been

even larger had the industry remained a state monopoly (Branston, 1999). Thisstudy, however, is acutely sensitive to assumptions made about theperformance of the enterprises had they remained in the state sector, whichis ultimately an unknown. Less difficult to interpret are studies that show adisparity in the distribution of the welfare gains between different consumergroups (e.g. Hancock and Waddams Price, 1995; Waddams Price and Hancock,1998). The above price figures are averages masking variations in the pricechanges between different consumers. State ownership is associated withcross-subsidies and “no undue discrimination” clauses that lead to uniformpricing. Privatisation, especially when coupled with competition, can beexpected to lead to prices more closely related to the marginal costs of

supplying particular users. This outcome has also been promoted by theregulators in the UK. As a result, users with lower marginal costs, usuallylarger users, have tended to receive bigger reductions in charges than smaller,often poorer consumers that are more costly to serve. In this sense it has notproved possible for regulators neatly to separate the pursuit of economicefficiency from the social consequences of their decisions (Baldwin and Cave,1999, pp. 80-81).

A full analysis of the welfare gains from privatisation needs also to addressthe distribution of the economic benefits between consumers and investors.Profitability was buoyant in the privatised utilities especially in the early years

after privatisation. For example, the rate of return on capital employed in thewater industry rose from an average of 9.8 per cent at privatisation in 1989 to11.1 per cent by 1996/1997; in electricity the increase was larger, with averagereturns rising from around 4 per cent in generation and 6.5 per cent indistribution and supply to around 11 per cent and 8.8 per cent respectively,between 1990/1991 and 1995/1996. As a result, and because the shares werefloated at attractive prices, investors initially benefited from large, sometimesspectacular rises in share values. One calculation (Parker, 1997) suggests that


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while there has been a variance in returns over the years and across theregulated industries, in general individual investors who bought shares in theprivatised utilities at flotation obtained returns on their investment up to theend of April 1997 exceeding 10 per cent per annum in real terms. The averagereturn in the water sector was 24 per cent and in the electricity distribution andsupply sector 38 per cent a year. The latter figure was buoyed up by takeoverbids in the mid-1990s for distribution and supply companies in England andWales[2].

Returns to investors in the UK following privatisation were high and itseems higher than government anticipated at the time of the sell-offs. The highprofits and shareholder returns have been attributed either to the companiesexploiting their market power in the face of lax regulation or to governmentunder-estimating the scope for cost savings following privatisation (e.g.Boardman and Laurin, 1998; Dnes et al., 1998). Opinion seems to be divided on

which of these explanations is the more important, probably both apply. Whatis clear is that the regulators have been able to respond fully only when theprice caps have come up for reconsideration, at so-called “periodic reviews”(although some regulators, notably the water regulator, intervened earlier andin the other industries companies were successfully cajoled from time to timenot to increase their prices by the maximum permitted under the price cap).The periodic review timetable involves price reviews normally every five years.This has meant a time lag of up to five years from the time extra efficiencysavings were made (savings above those factored into the price cap) to the timethese savings could be properly reflected in lower consumer prices. In themeantime, shareholders gained.

The lag in adjusting prices under the UK price cap regime is the reason thatreturns to investors in many of the utility stocks have been lower in morerecent times. The price caps were tightened in telecommunications and gas on anumber of occasions from the 1980s and in the electricity and water sectors in1995 and 1999. The 1999 price reviews by the electricity and water regulatorswill mean sharp price reductions to consumers and hence lower profits to thecompanies. For example, the water regulator has planned for water bills to be15 per cent lower in real terms by 2005. This follows the first ten years afterprivatisation in which water charges rose and suggests a shift in thedistribution of the efficiency gains from shareholders to consumers. Moregenerally, across the regulated industries regulatory tightening has led toprofitability reducing towards a normal level or closer equivalence to the costof capital.

Regulation and regulatory riskThe above discussion reflects changes that have occurred in the privatised,regulated industries in the UK since privatisation and should be educational for

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those countries that have more recently privatised their public utilities or areplanning to do so.

Overall the results suggest that while the separate contributions of privatisation, competition, regulation and technology remain unclear, intelecommunications, gas and electricity in particular there have been somelarge efficiency improvements, especially since regulatory and competitivepressures intensified in the 1990s. Initially investors benefited from highreturns on their investments in the privatised utilities, but over time thebalance of the distribution of the efficiency gains has been moving in favour of consumers, with some consumer groups benefiting more than others. At thesame time, however, the performance studies in Table I confirm that efficiencygains following privatisation are by no means guaranteed. Performance may bedisappointing where competition and regulation do not change followingprivatisation in such a way as to stimulate management to improve the

operation of their business.The following discussion looks at the changes in the operating environment

faced by the privatised, regulated industries and in particular the nature of regulatory risk. An appreciation of this environment is necessary for anunderstanding of the context in which management strategies are formulatedand implemented in regulated sectors, as discussed later. Regulation involves acomplex balancing act between advancing the interests of consumers, theinterests of investors in the incumbent utility, and the needs of potentialcompetitors. This involves inevitable tensions. Under a well-functioningregulatory structure, whatever its precise form, there should be scope forregulators to use their judgement and there should be scope for “discovery” and

“learning” as the markets change and adapt (Burton, 1997). But at the sametime a well-functioning regulatory structure avoids high levels of regulatoryuncertainty or regulatory risk. All privatised companies face normalcommercial risk to do with investing, producing and competing in theprivate sector, but regulated enterprises face an additional risk that relates tothe threat from regulatory intervention. The objective of regulation should beto protect the consumer, while providing an environment where the industrycan invest with a high degree of confidence that profits legitimately made arenot eroded by vexatious regulation. Otherwise, regulation will seriously distortmanagement strategies.

Regulatory risk arises from the nature of the regulatory rules and practices.Rules establish the degree of inherent risk by determining the extent to whichregulatory interventions are discretionary. The more rule based the regulation,the less the scope for regulatory discretion. Practice enters into regulatory riskthrough the interpretation the regulator and others (notably government) placeon the rules. Related to practice are the information asymmetries inherent inregulation. The companies can be expected to have superior information abouttheir costs of production, future investment plans and price elasticities; while


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the function of the regulator is to encourage companies to supply thisinformation so that proper regulatory decisions can be made on prices, profitsand the quality of service. For example, only when the regulator has a goodidea about the price elasticities of the companies’ outputs, their cost functionsand investment plans can prices be set so as to achieve a normal rate of returnon capital. At the same time, the regulated companies must enter intoinvestment programmes often involving appreciable sunk costs. Once havinginvested, the regulated companies can suffer from “hold up” (Hart and Moore,1988). In the absence of safeguards the regulator could drive down pricestowards the short-run marginal costs of production leading to financial losses.

Wherever there are sunk costs, as inevitably there are in network industriesinvolving large, dedicated investments in pipes, transmission lines, watertreatment plants and so on, the regulated companies are at risk. Thisregulatory risk arises from uncertainty about the future actions of the regulator

at the time of the investment. Comparing two regulatory regimes, everythingelse being equal, that which has the lower regulatory risk will have the lowercost of capital. The degree of correlation between returns on a company’sshares and returns in the stock market as a whole is estimated using acoefficient called beta. The basic premise is that investors require a higherexpected return on any investment (a “risk premium”) in order to compensatethem for the higher risk to returns on that investment, as measured by thevariability of those returns. A comparison of beta values for electricity andwater utilities in the USA and UK shows that the US utilities are judged byinvestors to have a lower risk (Grout, 1997). Whereas UK utilities tend to havebeta values of around 0.6 upwards, US utilities tend to have values

significantly lower than this. For example, one study found that the beta valuefor the gas sector was 0.84 in the UK but 0.2 in the USA. The comparablefigures for the water industry was 0.67 and 0.29 and for telecommunications0.87 and 0.52 (Oxera, 1996).

A number of factors determine beta values. But the lower regulatory riskimplied by the beta values for regulated utilities in US financial markets is, inpart, a product of rate of return regulation compared with price cap regulation(Alexander and Irwin, 1996). Rate of return regulation establishes a target rateof return. While not exactly guaranteeing a given profit, this method of regulation is intended to be more certain in terms of the profit outcome than is

the case in a price cap regime. Another reason for the lower beta values in theUSA relates to the maturity of the regulatory system. As a regulatory systemages the more learning or knowledge about the way it operates and itsconsequences result. Such knowledge reduces investor risk. The US has amature regulatory system, whereas those in many other parts of the world arenew and largely untested.

In the UK at privatisation the goal was to design a regulatory system thatover time would minimise regulatory risk while maximising efficiency

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incentives. This has not proved easy to achieve. Where regulation is new thereis a need to establish a regulatory system that permits flexibility toaccommodate learning about regulation even at the cost of some regulatoryunpredictability. But changes in the regulatory rules and practices lead toclashes with the regulated companies. For example, in 1999 the water andsewerage companies argued publicly with their regulator (OFWAT) over costof capital calculations and future investment needs during negotiations overrevised price caps. More generally, the following have been particular areas of disagreement:

. The rights of regulators to obtain information which they consider theyneed to regulate effectively – this reflects the information asymmetry inregulated markets.

. The proper valuation of capital stock, asset values and the setting of appropriate rates of return that enter into the setting of the price cap. Thishas been complicated in the UK by the discrepancy between the marketvaluation of the company at privatisation and its net book value, knownas the “discount” at privatisation; for example British Gas atprivatisation, where the market to asset value ratio (MAR) was 60 percent, and the water and sewerage sector where it was 10 per cent. Theregulatory book value (RBV) determines allowed depreciation chargesand returns to investors and depends upon which capital valuation isused. Where acquisition costs are used windfalls to shareholders areremoved but as the assets at privatisation are eventually replaced priceswill rise, reflecting (higher) replacement costs (Newbery, 1997; Vass, 1997,

1999). The result is an inter-generational redistribution of income infavour of current consumers who do not pay the true long-run marginalcosts of their supply. The implications of a change in valuation can bevery significant. When the assets of the gas transmission operator,Transco, were adjusted to allow for the discount at privatisation,following a Monopolies and Mergers Commission inquiry (MMC, 1997),the result was a write-off to reserves of £4.9bn.

. The extent to which the regulator should be allowed to alter “the rules of the game”, particularly in the UK through a change in the company’soperating licence or through a change in interpretation, for instance overwhat is the level of depreciation charge that should be permitted to enterinto a company’s cost structure when setting prices.

. The extent to which regulators should favour new operators over theincumbent firm so as to promote competition. The regulator may need totilt “the playing field” to encourage new entrants in the face of marketdominance by the incumbent operator. In the UK the telecommunicationsregulator protected the second network provider, MercuryCommunications, from competition from other new market entrants


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until 1991 to allow it to become established. The regulators have alsointervened to ensure that new entrants can access the incumbent’snetwork at a reasonable charge by regulating network access charges.Regulators will have to regulate and police market entry where theincumbent firm retains ownership of an essential asset, notably thenetwork (Armstrong et al., 1996).

Above all it is important to recognise that regulation influences the nature of the markets that evolve. Instead of resources being attracted to areas of greatest need, with potentially the highest welfare gains, they may be attractedto areas where access is permitted or short-term profit is highest given theregulatory constraints. This means that regulated industries operate in adifferent external environment to other privatised firms. Managers inprivatised, regulated companies must manage their businesses in the face of commercial pressures and regulatory interventions. The impact of regulation

on strategy in privatised industries is now discussed.

Strategy in a regulated environmentPrivatisation, competition and regulation force management to reconsider howbest to manage their businesses. In effect, managers of former state-ownedfirms need to re-conceptualise the basis on which they do business and developstrategies accordingly. In the face of information asymmetries and regulatoryrisk, management involves the normal analysing, planning and reaction tomarket signals, as well as an on-going interaction with the regulatory office. Inthis section of the paper the discussion turns to the inter-relationship betweencompetition, regulation and organisational performance from the perspective of strategy formulation and implementation in privatised companies.

Regulation can be viewed as a game played out over time between theregulator and the regulated company. This is likely to be played with particularferocity during the early years of privatisation, with regulator and regulatedposturing and re-positioning in the light of events. Following privatisation thedynamics of regulation involve both the regulator and management learningabout regulation and the optimal strategies to adopt. The regulatory offices willneed to appoint staff who will take time to learn about the markets they areregulating and how the dominant companies behave. The companies will needto learn how best to manage within the new regulatory system and this may

require the recruitment of new management with regulatory expertise.The regulated companies face market structures that are distorted bydecades of state ownership and by regulatory constraints relating to thedevelopment of competition, including network access codes and pricing andprofit limits. The complexity of regulation can act as a barrier to entry,especially where regulation costs fall more heavily on small companies than thelarge, dominant incumbent. The complexity is reflected in the costs of runningthe regulatory office, which may be met from operating licence fees levied on

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the turnover of the companies or by direct government financing, andcompliance costs in terms of the costs borne directly by companies in servicingthe regulatory system. The latter are often unquantified (there are no publiclyavailable figures for the UK) but are likely to be appreciable. Compliance costsarise in terms of the direct costs of administering the regulation (providingreturns to the regulator, replying to the regulator’s questions, etc.) andindirectly in terms of distortions to the enterprise’s corporate strategiesincluding pricing, outputs, employment and investment. In the USA regulatorycompliance costs have been estimated to total around $700bn compared withthe figure for direct regulatory costs borne by federal agencies of some $25bn(Hopkins, 1996).

The privatised company will need to learn how to operate now that it is nolonger directly accountable to a government department (or part of agovernment department). This requires new networks of relationships to be

developed: “The institutional change brought about by privatization has theeffect of reshaping sectoral networks and constructing fresh relationshipsbetween established actors” (Dudley, 1999, p. 53). This involves formulatingnew frames of reference involving new resource dependencies and a“reframing” of strategic orientation and priorities. This can extend to anattempt to change the “culture” within the organisation away from publicsector ways of operating, involving a complete review of management needs,operational goals, organisational structure, nature and location of the business,reporting and internal communication, and human resource managementpolicies (Parker, 1995a, b). There may be a need for new leadership alongsidenew methods of remunerating staff (more performance related), financial

restructuring and new financial systems (Andrews and Dowling, 1998). But inparticular, the regulated companies will need to reorientate to meeting theneeds of different stakeholders, including consumers who may now have achoice of suppliers and the regulators, who seriously impact on thedevelopment of the business.

The regulated company will need to develop internal systems and structuresthat support change, such as a new emphasis on marketing as markets areopened up to competition, while retaining the confidence of the regulator so asto avoid unpredicted and damaging regulatory interventions. At the same time,because the regulated company will hold information necessary for effective

regulation, notably market and cost data, it is in the interests of the regulatedoffice to cultivate an atmosphere of co-operation with the company. In thisenvironment cheating is most obviously an optimal strategy where it is a one-shot game with no on-going relationship. In practice, regulation is normally anon-going or “non-finite repeat game”, where it is to be expected that “cheating”will be penalised by the other party through future non-co-operation or “tit-for-tat” reaction. Regulation involves a tension between the desire of the companyto benefit its investors and the desire of the regulator to benefit consumers. But


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co-operation is optimal provided both parties see this as having a highercontinuing pay-off than conflict. This does not rule out occasional argumentbetween the regulated and the regulator, but this is unlikely to amount to acomplete breaking-off of relations because the regulator needs the company toco-operate in providing information; while the company needs to head off damaging regulatory interventions. While there have been disagreementsbetween the regulators and their industries in the UK, sometimes heated,relations have never been allowed to deteriorate to the point where dialoguecompletely breaks down.

In the face of asset specificity it might be expected that the regulator wouldact opportunistically. As noted already, companies with high sunk costs maybe subject to “hold up”. Hence regulatory rules, such as legislation in the UKthat requires that the regulator must ensure that the companies are able tofinance their services, are there to reassure investors that the regulator will not

be allowed to act opportunistically and undermine the enterprise’s long-runexistence (although he may allow competition to do this in time). Without suchassurance investors could refuse to invest (e.g. fail to buy the privatisationshares), demand a sovereign guarantee (thus transferring risk back togovernment) or require a hefty risk premium, leading to a higher cost of capitalin the industry and a lower share price at privatisation. Similarly, in the face of information asymmetries the regulated company could act opportunisticallyand withhold or distort information that the regulator needs to regulateefficiently. Some reluctance to provide information that could be damaging tothe company, for example leading to a tighter price cap, is to be expected; butwithin the regulatory game such strategy is bounded by the net advantages of

maintaining the co-operation of the regulator. As a consequence, opportunisticbehaviour or “self seeking with guile” (Williamson, 1985) is unlikely to be theoptimal strategy for companies to follow or to follow for long. As Lapsley andKilpatrick (1997, p. 4) comment:

At the heart of the effective regulation of utilities sits the question of trust: the extent to whichconsumers, employees and the government can trust the individuals selected to act asregulators. In particular, the extent to which they can be trusted to discharge theirdiscretionary powers effectively and the extent to which the regulator can trust the regulateeto act in a manner which may not exploit any advantage, e.g. informational, actual orperceived, which it has over the regulator.

Therefore maintaining a degree of trust as the basis for co-operation with theregulator is a constraint on management strategies in regulated environments.Strategies need to be formulated with cognisance of the rules of the regulatoryregime and with a view as to whether they are likely to provoke the regulator tointervene. The UK experience suggests, for example, that aggressivecompetition against new entrants is likely to produce a regulatory response.Regulated companies do not have the same freedom to determine prices,outputs and capital programmes that exist for other private-sector enterprises.

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At the same time, regulated companies will be able to capitalise on theirgrowing knowledge of how to manage in a regulated environment and seekcompetitive advantage by exploiting this expertise. For instance, some UKwater and electricity companies have extended their businesses overseas aspart of a “globalisation strategy”, carrying over their knowledge of UKregulation into other regulated environments. An alternative strategy that maybe pursued, possibly simultaneously, is to diversify into non-regulated butrelated activities; for example water companies in England and Wales havebought into waste management. In essence, what is happening is thatcompanies are developing a core competence in managing regulated businessesworldwide and using what they believe to be their core competence inmanaging infrastructure assets to expand outside the scope of regulation. Inboth cases, however, there can be no guarantee of success. The watercompanies have lost large amounts through unwise diversification.

Dominant state-owned utilities gained their dominance not throughcompetitive advantages in the marketplace, but through legislative fiat. Theymay have few if any true competitive advantages when faced by acommercial environment. For this reason, if they are to survive, privatisedutilities need to adapt quickly to the new agenda. Management need toidentify the value drivers in their business in the new operating environmentand develop resources or capabilities accordingly (Hosein, 1999). This isconsistent with a “resource-based” view of the firm that sees competitiveadvantage lying not simply in terms of competitive positioning in the marketplace, but in terms of internal capabilities or competencies. Resource-basedtheory suggests that firms must continually enhance their resources and

capabilities to take advantage of changing market conditions (Mahoney andPandian, 1992; Eriksen and Mikkelsen, 1996; Foss, 1997). This suggests thatprivatised firms will need either to buy in or develop internally newcompetencies including innovation, financial and marketing capabilities. Interms of competitive positioning, organisations may attempt to capitalise ontheir head-start in the market and build upon brand recognition, to differentiatetheir offer from that of the new, competing companies. Branding enables firmsto adopt a differentiation strategy with premium prices for premium brands.Where this is not possible, and it may not be for a number of the productsproduced by utility firms (branding effectively telephone calls, tap water, gas

therms or electricity kilowatts is tricky), firms tend to be driven towards alowest-cost supplier strategy for survival (Porter, 1980). In the UK, water,electricity and gas suppliers have tried to develop brand recognition, but withthe exception of the incumbent supplier in a region, who may retain somecustomer loyalty, branding appears to have been of limited success. Intelecommunications BT has arguably been more successful in its brandingstrategy, though even here many customers have switched to cheaperproviders. In an increasingly competitive environment it is little wonder that


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the privatised utilities have been driven into major cost-cutting programmes. Alowest cost strategy means a desperate “downsizing” to enable a supplier toprice more cheaply than its competitors.

In the UK some privatised firms have embarked on rapid and ruthless costcutting and restructuring, including hiving-off parts of their business. Othershave adopted a more incremental approach with only gradual changes instructure. Some have anticipated change, while others have delayed theirresponse. Research into change management in the water industry in Englandand Wales has shown that discontinuous or punctuated change programmescan be equally as effective (or ineffective) as more continuous change methods(Dean et al., 1999). This confirms that there is no one formula for successfulchange management in regulated markets, anymore than there is in acompetitive one; although it can be expected that the pressures on managementto implement change will increase as regulation and competition intensify. This

is evidenced by the experiences of BT, which went through numerousreorganisations in the 1980s and 1990s, and British Gas, where at privatisationits management naıvely believed that the company’s market dominance wassafe. After 1992 the company had to restructure extensively in the face of competition and regulatory pressures. Other research (Harris et al., 1998; Coxet al., 1999) has detailed how companies react in different ways and at differenttimes to the new commercial pressures by realigning and reassessing theirsupply-chain management. Some of the results from this research, whichinvolved 28 privatised firms in the UK including British Gas, seven watercompanies and ten electricity utilities, are given in Tables II and III.

In the study only two out of the 28 privatised firms reported no significant

change in the methods used to procure inputs. Where changes occurred mosthad been undertaken within the three years before or after privatisation(Table II). This indicates a search for new methods of procurement in the faceof the new competitive and regulatory pressures introduced by privatisation.The research found that initially the chief driver of change was cost reductionespecially through reducing employment. Often only later was procurementpolicy reconsidered in terms of a strategic appraisal of how value could be best

Timing of change No. of companies %

More than 3 years before privatisation 2 70-3 years before privatisation 5 18During year of privatisation 3 110-3 years after privatisation 9 32More than 3 years after privatisation 7 25No change 2 7Total 28 100

Source: Cox et al. (1999, Table 4.2, p. 51)

Table II.Timing of thechanges in thestructure of procurement

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added to the business by managing the supply chain more effectively. Thissometimes meant employing a new head of procurement from outside theorganisation to introduce new ways of working. In time this led to morestrategic methods of procurement, including benchmarking best practice,strategic supplier alliances and network sourcing. Prior to privatisation thesemethods were used by very few of the firms studied. Most of the purchasing

techniques used were traditional and concerned with order contracting,processing, expediting and inspecting (the top seven items in Table III). Insummary, the study found evidence that procurement practices which sufficedunder public ownership, where costs and speed to market were less important,proved inadequate when the companies had to survive in more competitivemarkets and in the face of tightening regulation. Another study (Parker, 1995a,b) has detailed the wider internal changes that occurred in a number of privatised companies in the UK as they have endeavoured to come to termswith operating in the private sector. This study identified changes in goals,organisational structure, management, employment, communication andreporting systems and the nature and location of the business.

Finally, when markets are opened up to competition after a history of restricted entry, in the early stages of market liberalisation industries may tendto become fragmented with lots of new players. Over time, however, the moremarginal players are likely to be forced out and the industry will re-consolidateas occurred in US airlines in the 1980s. This is proving true of the UKtelecommunications, gas and electricity markets and is likely to be true of many of the newly liberalised markets in other countries. Looking specifically

Purchasing tools and techniques Before After

Writing tender specifications 13 12

Organising bids 19 18Negotiating 17 24Awarding contracts 23 23Expediting 17 13Inspection of goods on arrival 10 10Vendor accreditation 11 20Formal vendor selection mechanisms 9 23Benchmarking/“best practice” 3 22Purchasing portfolio analysis 3 22Strategic source planning 3 21Purchase price cost analysis 7 19Strategic supplier alliances 3 17Partnership sourcing 2 20

Network sourcing 1 11Relational competence analysis 1 10

Source: Cox et al. (1999, Table 4.18, p. 67)

Table III.Procurement tools

and techniques most

commonly usedbefore and after

privatisation


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at the incumbent companies, they may be expected during the reorienting of their businesses to seek out possible economies of scale and scope and higherlevels of dynamic efficiency (in terms of innovations in products and processes)through acquisitions and alliances. On the one hand, the motivation may beentrepreneurial in terms of expanding the business and taking maximumadvantage of the new open environment to increase shareholder value. On theother hand, restructuring may simply be defensively motivated with a view toprotecting markets from competition. Acquisitions and alliances may eliminatepossible competitors and produce formidable barriers to entry in the form of size and market coverage. Certainly telecommunications has seen an explosionof alliances over the last ten years in response to markets being liberalised, of which Concert (BT, AT&T and others) and Global One (France Telecom,Deutsche Telecom and Sprint of the USA) were but two early examples. Morerecently there has been increased activity in the form of mergers and takeovers.

The aborted bid by Deutsche Telecom for Telecom Italia, that was eventuallysold to Olivetti, is a portent of what is likely to evolve in terms of consolidationin the telecommunications sector in Europe over the next few years. In the UKboth the water and energy industries have been affected by numeroustakeovers since privatisation.

ConclusionsFor much of the twentieth century state-owned utilities were favoured overprivately-owned suppliers. In the last 15 years the pendulum has swung theother way favouring privatisation and state regulatory structures for monopolyactivities. This study has been concerned with the issues of post-privatisation

performance, regulatory risk and strategies for survival in a regulatedenvironment. The main conclusions are:

(1) The evidence from the UK suggests that privatisation of public utilities isassociated with performance improvements especially in terms of increased labour productivity. This was reflected initially mainly in theform of healthy returns to investors and only later in terms of significantlylower prices to consumers. It is difficult, however, to separate out theindividual contributions of ownership change, competition, regulationand technological change to this performance improvement. What can besaid is that where privatisation is not accompanied by more competitionor regulation that produces similar pressures on management to raiseefficiency and benefit consumers, the incentives for management topursue efficiency gains are likely to be greatly diminished.

(2) Regulatory risk should be minimised while achieving the regulatorygoals so as to encourage investment. At the same time, it is to beexpected that regulatory “discovery” or “learning” will occur inregulated markets, especially in the early years, leading to changes andadaptations. There is a balance to be achieved between regulatory risk

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and the need for regulation to evolve so as to better protect consumersand maximise efficiency incentives. On the basis of the evidence from theUK there is an inevitable tension between the regulated and regulator,leading to occasional disputes over appropriate practices. In privatised,regulated markets it is to be expected that there will be a conflictbetween management’s wish to pursue shareholder value and theregulator’s concern to protect consumers from monopoly abuse.

(3) Regulation is a non-finite repeat game in which it is to be expectedthat it will usually be in the interests of both the regulator andregulated parties to maintain co-operation, although this does notrule out disagreements from time to time. In this environment themanagement of privatised companies need to learn how best tomanage within the regulatory rules so as to achieve shareholdervalue. Success no longer depends upon favours from the state but

upon operating successfully in regulated and increasingly competitivemarkets. Management will therefore need to assess:. what are the value drivers in the new business environment;. how best to align structures and processes including supply chains to

maximise value;. how best to anticipate competition and regulatory interventions that

may impact on value; and. the scope for alliances, acquisitions and mergers for both defensive

and offensive purposes in the market place.

Above all, management of privatised utilities need to recognise that the currentmarket dominance of their firm probably owes very little to competitivesuccess and much more to the legal privileges that are now being removed.Once markets are liberalised the incumbent former monopolies are extremelyvulnerable unless they can identify and develop the competencies necessary tothrive in regulated and increasingly competitive markets. They have anadvantage. Their existing size and market penetration provides time toundertake the strategic reappraisal and to experiment with strategies. Theincumbent should benefit from economies of scale and scope, learning curveadvantages, control of strategic assets and customer switching costs. But in thelonger term such advantages are unlikely to provide sufficient protection

against the effects of competition and regulatory pressures. The histories of BT, British Gas and the electricity companies in the UK since privatisation arealready educational in this respect.

Notes

1. The electricity industries in Scotland and Northern Ireland are separately structured andcompetition has been less intense. In Scotland the reduction in domestic charges up to 1997was about 7 per cent and in Northern Ireland a miserly 0.4 per cent.


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2. The end of April 1997 is chosen because May saw the election of a Labour Government. Thisgovernment imposed a £5.2bn “windfall profits” tax on the utilities, including the mainairport operator BAA, in an attempt to recoup some of the large profits made. The figuresquoted are internal rates of return based on capital gains, dividends and amounts invested.

For the method of calculation see Parker (1997).

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