Bass has yet to deliver a convincing case

Perhaps predictably, Bass has lost round one of its attempt to merge its brewing interests with Carlsberg-Tetley. Equally predictably - for Bass drops up to pounds 60m if this deal does not go through - its threat to pull out altogether in the event of the Government referring the deal to the Monopolies and Mergers Commission has proved so much hot air. Bass is going to pursue its case through to the bitter end, which in this case is all too probable.

How it is that Bass came to think a deal that would give the new group nearly 40 per cent of the UK beer market even remotely possible is something of a mystery. There are very few industries (national newspapers is a rare example) where such a degree of concentration would be tolerated. But to be fair on Bass, the authorities have given some encouragement to the view that this might just be allowed. For a start there was Michael Heseltine, who while president of the Board of Trade championed a "big is beautiful, anything goes" mergers policy.

The present incumbent, Ian Lang, didn't actually make the decision, but it was under his rule that the DTI allowed Scottish & Newcastle to acquire Courage with only limited conditions. By waving through this deal, the authorities appeared to abandon the old, unwritten rule that any merger resulting in a market share of more than a quarter would automatically get referred. Scottish & Newcastle ended up with more than 30 per cent of the market, encouraging Bass to believe further consolidation perfectly acceptable.

Since then Mr Lang has attempted to shift the emphasis back to a more overtly pro-competition stance. Even so, Bass continued to believe the authorities could be convinced. Good progress has been made, it argues, in separating retail from production, and in any case the merger would allow an orderly rationalisation of excess capacity. Furthermore, last week's decision to allow the British Airways link up with American, subject to conditions, seemed further evidence that with the right concessions, Bass could succeed too.

But although Bass can reasonably point to inconsistencies in policy, it surely couldn't honestly have thought such a radical shake-up of the industry would be allowed without thorough investigation, whatever the safeguards offered. In the absence of any convincing arguments to the contrary, it is hard to see how such concentration could do anything other than harm consumer interests. With pounds 60m at risk should this deal fail, shareholders can only hope that so far Bass has kept its powder dry.

An old draft from New Labour

Not much evidence of New Labour in Frank Dobson's policy statement on the water industry issued yesterday. A quick read of its 11 pages reveals a quite unmistakable whiff of old attitudes mixed in with some familiar, tried and failed solutions.

The shadow environment secretary's starting point is that, in so far as the water industry is concerned, profit is still a dirty word, and as a result he's not going to allow water companies to make any. Depending on whom you talk to, for the Labour Party seems to have almost as many positions on these matters as the Tory Party does on Europe, the Dobson approach might apply to other utilities as well.

Politically, there is no doubt that he's on to a winner here, for most people take the view that since water and sewage are public services they should not be allowed to make profits period, let alone anything that might be regarded as "excess" profit. The unfortunate truth is that generally people don't understand the role of profit in public services. Seventeen years of Conservative Party rule does not seem to have changed attitudes very much on this front.

So with the ballot box in mind, Labour is probably backing the right horse. If it pursues this line of attack, however, it won't actually be doing anyone, least of all the public, any good. In fact, it will probably be harming the public interest. Here's why.

What Labour proposes is that profit be capped each year at a level it regards as reasonable and normal, and that to the extent that this is exceeded, the benefit should be handed back to customers in the form of lower prices. There is nothing particularly new about this. A variant of it was used to regulate some of our utilities in the last century and it is a common form of economic regulation in other countries, particularly the US. In the jargon it is known as "annual formula profit sharing".

But just because it has been tried before doesn't mean it has much to commend it. In truth this is a flawed approach, the effect of which, when added to the windfall profit tax, would be highly retrogressive, returning these companies to the plodding, inefficient state they were in as nationalised industries. Perhaps that is what the public wants, but it carries with it a big sacrifice.

The present system of price cap regulation provides a powerful incentive to improve efficiency, for it allows companies to keep any profits they earn over and above the regulator's assumed "reasonable" level. The result, particularly in the years immediately after privatisation, is much higher profits than might be thought appropriate.

However, the system allows this to be corrected through periodic reviews of charges when the regulator claims for the customer all the efficiency gains achieved in the previous five years. What Labour wants to do is move these reviews on to an annual basis and, moreover, hand back to customers at least some of any profits earnt in the previous year over and above the established "normal" level. Mr Dobson is intentionally vague as to how much.

It can readily be seen that the effect of this will be to remove all incentive to efficiency. Far from benefiting customers, it would ultimately harm them, for it would result in higher long-term prices, not lower ones.

There's not much chance of Mr Dobson changing his mind on this, but in the line of duty and without any hope of Britain's government-in-waiting listening to sense on this issue, here's a possible compromise. Ian Byatt, the water regulator, is already experimenting with a voluntary form of profit sharing which seems to answer some of Labour's concerns. Companies which voluntarily forego some of their allowed price increase are allowed to roll this benefit over into the next price review period.

The effect of this is to change the profile of profits and prices. The present "excess" in profits is reduced but equally the extent of the customer claw back at the time of the review is limited too. In other words, customers get the benefit of efficiency gains immediately rather than having to wait for them. At the same time the system retains its present incentive to improved efficiency.

Then again, this is obviously too reasonable an approach for someone who believes that water privatisation is a "scandal", that Ofwat is "ineffective and inadequate", and that water companies routinely lie to their customers (yesterday's Labour Party document).

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