July 25, 2022 11:15 pm

The second pillar of affordability is Efficiency

One of these matters more than the other

This post is the second in a series outlining five pillars of affordability strategy for water and sewer utilities. Together, these pillars offer a practical way to think about affordability and how to manage it. My last post explained why quality is the first, most important pillar of affordability.

The second pillar of affordability is efficiency. Pursuant to affordability, utilities should operate at the lowest average cost possible without sacrificing quality or public trust. More than mere cost-cutting, efficiency requires utilities to deliver excellent service with low rate revenue requirements. The people who govern water systems are, by and large, pretty attuned to efficiency, at least in the abstract; they want to provide good service at a low price. But securing the kind of efficiency that really matters for affordability requires a focus on the costs that really matter and the value that utilities provide.

The small stuff and the big stuff

Back in the 1990s when I worked in financial consulting, I attended a small municipality’s council meeting that was focused on the city’s water and sewer utilities. Utility staff made lengthy presentations on a proposed biennial budget, a $20 million capital plan, and a new rate structure. The city council spent nearly an hour scrutinizing the budgets. They asked about contracting costs and staffing levels and so on—just the sort of oversight we’d expect from responsible officials.

But what made the meeting memorable was the donut discussion.

The proposed budget included $500 for donuts to celebrate operators’ birthdays. Holding up his highlighted copy of the proposed budget, one councilmember wondered aloud whether birthday donuts were an appropriate use of ratepayer dollars. Another member declared that the donuts were wasteful. Other councilmembers defended the donuts as a reasonable way to recognize employee dedication. The public works director was asked to justify the proposal. In a municipal budget with hundreds of line-items and tens of millions of dollars, this $500 donut line accounted for at least a third of the budget discussion. In the end, the council approved the donuts.

Moments later the council approved the $20 million capital plan with less than ten minutes of questions for utility staff and zero discussion.

My aim here is not to criticize a city council or opine on the motivational value of donuts.* The point is that some decisions are more important for efficiency than others. A $500 donut budget doesn’t matter much, but there are countless ways that utilities can reduce costs significantly while maintaining or improving quality—from pump optimization to meter audits to chemical feeders to contracting. Innovative utility organizations are constantly on the lookout for such measures. But the efficiency gains that matter most for affordability follow wise big-ticket, big-picture decisions like supply sources, infrastructure investments, and staffing. The birthday donut budget won’t move the affordability needle—that new supply project probably will.

Greater efficiency with one weird trick

The single greatest factor that drives down a water utility’s average cost is scale. As I’ve written before, larger utilities can spread capital and operating costs over larger numbers of customers and larger volumes of water, which drives down average costs. These advantages give larger utilities stronger credit and bond ratings, allowing them to secure capital at lower interest rates. Larger utilities also enjoy bargaining power as buyers of chemicals, supplies, and equipment. Less obviously, larger utilities can attract and retain better employees, and enjoy greater financial stability and are less vulnerable to fluctuations in demand.** Larger organizations can more effectively leverage new technology.

These advantages can translate into dramatically lower prices for customers of larger utilities. Here’s some analysis from my latest nationally-representative price data (2021):

Statistical model controlling for ownership, source water, and region. Thin bars represent 95% confidence intervals.

What’s more, larger water systems provide higher quality service on average. Here’s the likelihood of a Safe Drinking Water Act (SDWA) violation in those same utilities from 2016-2020:

Statistical model controlling for ownership, source water, and region. Thin bars represent 95% confidence intervals.

Lower costs with higher performance is the practical definition of efficiency. 

So in addition to its many other merits, efficiency through consolidation turns out to be one of the most important ways to address affordability for the vast majority of U.S. utilities. Small systems can be consolidated into larger organizations even when they’re physically separate. Along with scrutinizing supplier contracts and meter audits, utilities ought to think about regionalizing administration, operations, water supplies, and everything else that they do.

Thrifty ≠ cheap

Efficiency is about the relationship between cost on one hand and product quantity and quality on the other hand. Unfortunately, interest in efficiency sometimes turns into an obsession with cost-cutting, because a water or sewer utility’s costs are much easier to observe than its quality. Running a facility to failure in order to keep prices low is not efficient. Putting off needed maintenance and upgrades isn’t efficient, either. Selecting the lowest-bid firm in contracting isn’t efficient if its work is slipshod. Low capital or operating costs do not imply greater efficiency without evidence of steady or improving quality.  

Utilities operate in a competitive labor market. The kinds of people we want running our critical infrastructure have the talent and skill to work in other fields. Attracting and retaining the best employees requires paying them competitive wages, providing strong benefits, and offering appealing perks—like birthday donuts! Low wages and cheap coffee in the break room don’t improve efficiency if quality, service, or public trust suffer due to staff turnover.

Pay that man his money (Photo: Wisconsin Public Radio)

A single-minded focus on cost-cutting also can lead to underinvestment in important projects and programs that do more than the regulatory minimum. Tap water aesthetics (taste, odor, color), improved customer service, robust financial reserves, attractive facilities, and public information campaigns are necessities masquerading as luxuries. It’s important not to let them fall under a sloppy budgetary axe. Lower costs don’t improve affordability if quality or confidence suffer.

Finally, efficiency doesn’t necessarily make water more affordable for economically vulnerable households. Next time I’ll introduce the third pillar of affordability: rate structures that help transform all that efficiency into low prices for low-income customers.

*A fresh, plain donut—maybe with a light maple glaze—definitely motivates me.

**More stable revenue allows large utilities to price water progressively, which I’ll discuss at length next time.  

For more data on the merits of scale, see a bunch of analysis here.

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