Jeremy Warner's Outlook: If users and operator alike are complaining about the CAA's ruling, maybe it's about right

UU: concentrating on core competence; Mighty Tesco less mighty overseas
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The Independent Online

Harry Bush, the head of economic regulation at the Civil Aviation Authority, seems to have alienated more or less everyone with his review of charging at Britain's major airports.

BAA condemns the proposals as failing to give proper incentives for the £9.5bn of investment planned for Heathrow, Gatwick and Stansted. British Airways says it is "extremely disappointed" with a determination that allows for another 50 per cent rise in charges after inflation at Heathrow. As for Michael O'Leary, the chief executive of Ryanair, his unsanitised comments are, as usual, quite unprintable, even though the proposed deregulation of pricing at Stansted might have been thought right up his street.

In other words, the regulator may actually have got his determination about right. If both users and operator think he's got it completely wrong, that would powerfully suggest the balance struck between these conflicting interests is spot on. However, if a judgement has to be made one way or the other, he seems if anything to have erred too much on the side of the operator, BAA. Despite its protests, BAA has ended up not with the unsatisfactory deal it sees, but a featherbedded one which goes some way to justifying the apparently inflated price Ferrovial and partners paid for the company last summer.

The regulator has been too generous in assuming a 6.2 per cent cost of capital. The real figure is likely to be much lower. But even assuming he's right, the pre-tax, real rate of return allowed of 11 per cent at Heathrow and 12.4 per cent at Gatwick is still an extraordinarily generous one.

To achieve that, BAA needs to deliver only a 1 per cent improvement in operating efficiencies each year, which should be a stroll in the park. Where else other than a regulated monopoly would it be possible to make guaranteed returns of the order suggested?

As for deregulation at Stansted, that's no more than a reflection of reality. BAA has never been able to charge up to its regulated price cap at Stansted in any case. Whether it makes construction of a second runway at Stansted, the Government's preferred option for expanding airport capacity in the South East, more or less likely is an interesting question.

In theory, it should allow BAA to charge what it likes at Stansted in pursuit of financing the costs of a second runway. Yet this would only be possible if Stansted users were a captive market. As the biggest user, Ryanair, has often warned, in fact there are plenty of other options, not least Luton. If prices rose too far, Ryanair and others would attempt to vote with their feet.

The solution to these problems is the self-evident one of splitting up the BAA airports into separate ownership, allowing the market to dictate where capacity is built and how it is financed. BAA cannot answer properly to the needs of users at Heathrow if it is constantly juggling these interests with competing ones at Gatwick and Stansted. Nor can users properly assess whether or not they are getting a fair deal.

The Office of Fair Trading is expected shortly to refer the airports market to the Competition Authority to decide these and other issues. BAA should have been broken up into rival airports when it was first privatised in the 1990s. The interests of consumers would have been better served by such an outcome.

Unfortunately, it was the money raising demands of the Treasury which took priority - that and the determination of the politicians to maintain control over such matters as where extra landing capacity might be located. Today, there is an opportunity to reverse this mistake. Despite its whingeing, Ferrovial did well out of yesterday's pricing proposals. It might do much worse out of the separate Competition Commission inquiry.

UU: concentrating on core competence

Philip Green was feeling particularly pleased with himself yesterday. No, not that Philip Green, but the one who runs United Utilities. The share price has climbed from the moment he stepped into the chief executive's shoes from P&O Nedlloyd last April.

While that's got quite a lot to do with the current craze among private equity investors for infrastructure assets, the market seems also fully to have bought into his simple, no-nonsense strategy of focusing entirely on the core business of managing water and electricity assets. Some of the first fruits of that approach were evident in yesterday's first-half profits numbers.

Yet ironically, the company has thus far proved rather better at managing these assets for others than it has in its own water and electricity business in the North West, where public sector attitudes to customer service and performance remain entrenched. The scope for improvement is therefore significant. Mr Green's experience in logistics equips him uniquely well for the task in hand.

He's also unsentimental in his attitude to anything surplus to this approach. Vertex, the company's business process outsourcing (BPO) offshoot, was formally put up for sale yesterday after a number of approaches from interested buyers. This is wise, not just because Vertex doesn't fit with the core competence ethos, but also because faced by the onslaught of low-cost competition from India and the Far East, there may be little future for such British-based enterprises. Mr Green is exiting while it is still possible to put a decent price on the business.

The longer-term outlook for British-based players in the BPO market, whether they be LogicaCMG or Capita (very different companies specialising in very different forms of work, admittedly, but all essentially in the same space) is in my view extremely bearish.

As companies attempt to streamline themselves into concentrating on what they do best, much of the rest of the value chain will be outsourced to others, who can do it better and cheaper. Yet the bulk of this business will go not to Vertex and other British players, but offshore to India and anywhere else where the prices are low and the solutions are cleverer.

Only in the public sector, where political sensitivities constrain the offshoring of jobs to India and elsewhere, will contracts remain for the outmoded business models of the British BPO operators.

But all this is by the by. Fortunately for United Utilities, there are some things which cannot be offshored. The coalface management of water and electricity assets - dealing with a leaking water main, say - is one of them. As a consequence, there is probably some sort of a future for Mr Green's "contract solutions" business, which offers management services to other owners of water and electricity assets. Meanwhile, the opportunities for operational improvement at United Utilities, whether through its own efforts or merely by outsourcing to others, remain boundless.

Mighty Tesco less mighty overseas

There's nothing like a tough trading environment to sort the wheat from the chaff, and so it proving on the high street. While Woolworths is floundering, Tesco is continuing to forge ahead, apparently oblivious to the weak retail market cited by Woolworths in excuse for yesterday's trading bombshell.

Yet despite its success at home, and some notable achievements overseas, Tesco is still being outgunned by bigger international rivals in the race to go global.

Nowhere was this more evident than in the recent news that the company has been beaten to the punch by Wal-Mart in partnering with Sunil Mittal to exploit the fast growing Indian retail market. Tesco has also recently been outbid by Carrefour for Ahold's supermarkets business in Poland. In both cases, the bigger balance sheets of overseas rivals has made the difference. Because they are bigger, they can afford to take greater risks. Tesco may be the Darth Vader of the British retail scene, but its domestic franchise is tiny by comparison with that of Wal-Mart.

Still, there is something to be said for caution, and if it results in the sort of numbers trotted out yesterday, who's complaining?

j.warner@independent.co.uk

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