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Prudent water utilities recognize the need to manage assets like a business.
By Paul D. May, P.E., Assistant Executive Director, Northwest Suburban Municipal Joint Action Water Agency - October 12, 2016
“I want the government to run like a business.”
This statement has been made by countless citizens, frustrated with perceived government mismanagement and political shenanigans. Others counter that government should not function as a business—government provides community services which require empathy, collaboration between groups, and compromise. Perhaps this paradox is best resolved by making a distinction between the provision of municipal goods and municipal services.
While government services, such as police, fire and transportation, are visible and easily recognized, municipal governments also generate and distribute real goods, in a manner nearly identical to any corporate business. For example, there are more than 50,000 public water systems in the United States, which provide drinking water to 280 million persons (EPA). Production and distribution of water in these systems closely mirrors that of any factory producing marketable goods.
Just as a manufacturer produces widgets in a factory, a municipality produces drinking water in a treatment plant. Both goods—the widgets and the drinking water—have an inherent value, which a consumer desires and is willing to pay for. The factory uses shipping services to distribute the widgets to the consumer, whereas the municipality uses pipe infrastructure to distribute water to its consumers. At the point of delivery, the sale occurs, and the value of the product (whether widgets or drinking water), is recognized by the consumer. In fact, a nearly identical correlation exists with the many corporate utility enterprises in our nation, especially natural gas and electric utilities.
So perhaps a case can be made that government utilities should run more like businesses.
The corporate sector often identifies efficiencies by finding new ways to produce and deliver goods as cost-effectively as possible. Municipalities can learn a lot from this practice even when the underlying motive is not profit, but the production and delivery of a public good in the most effective manner.
However, many municipal utilities have historically functioned more like service industries than producers of goods. For example, government and corporate utilities have much different expectations relative to market performance as monitored by investors or consumers. Corporate utilities issue financial reports which provide detailed performance metrics and ratios, including data relative to asset management and delivery efficiency.
If assets are not being appropriately preserved, or if the product is not efficiently delivered, the market will force a correction. Investors will determine that neglected infrastructure investment will result in higher long-term costs, or that delivery failures will result in expenses which are not offset with revenue—both of which will erode fiscal health. As a result, the stock value will drop.
Seeking to avoid such a fate, corporate utilities recognize that delivery of their product to the consumer depends greatly on the integrity and reliability of their infrastructure. Therefore, assets are closely monitored and long-term maintenance and replacement plans are established to stabilize costs, maximize asset life and reduce delivery losses.
The U.S. Environmental Protection Agency reports the average amount of water wasted—that is, lost—within municipal utilities due to infrastructure conditions is 16 percent. That is, 16 percent of a good that is produced by the municipality but never delivered to market, and for which there is distinct cost and an inherit value, but no corresponding revenue. In the Chicago region alone, 26 billion gallons of drinking water was produced but not delivered to consumers in 2010, goods with a market value of more than $100 million (Metropolitan Planning Council).
As water infrastructure approaches the end of its useful life, inefficiencies become increasingly apparent and difficult to manage, first as wasted and unused drinking water (lost revenue), then as infrastructure reinvestment needs (capital costs). In order to address this issue, many municipal utilities are now transitioning from a service-based strategy to a goods-based strategy which more closely replicates the corporate sector and acknowledges the value of the goods produced.
Service-based strategy:
Provision of government services with an emphasis on customer satisfaction, individual service, and communal benefit – funded by general taxpayer contributions rather than consumption fees or unit/cost measurement.
Goods-based strategy:
Production and delivery of municipal goods with an emphasis on establishing the true value of goods based-on full life cycle costs, long-term financial viability, and infrastructure stability – funded by user consumption fees and unit/cost measurement.
Prudent utility managers are now recognizing infrastructure as both an asset and a liability. Water infrastructure is not only a liability due to depreciation, but also because this infrastructure will ultimately need to be replaced. While depreciation captures a portion of this cost, a well prepared asset management plan is necessary to identify full life-cycle costs of buried utilities.
Infrastructure replacement costs are quite formidable when a funding strategy is not in place, but can be appropriately managed when the costs are accounted for over the full life of the asset—the methodology employed in the corporate sector.
Conversion to a goods-based strategy is a challenging transition for many in the water industry, and the fragmented nature of 50,000 public water agencies results in variable and disparate implementation. Nonetheless, municipal utility managers are recognizing the value of asset management and water audit tools to communicate the importance of strategic infrastructure management to public officials and consumers. The objective, of course, is to generate a long-term operational plan that ensures the production of safe drinking water in modern facilities, and the distribution of that product (good) in an efficient, cost-effective and environmentally sound manner.
Embracing the beneficial practices of running an efficient and sustainable water business within our municipal governance structure will lead to increased efficiency, more stable long-term rates for customers, greater stewardship for shared natural resources and improved safety for our communities.
Interested parties may find useful asset management tools on the EPA website www.epa.gov, and water audit/loss management tools on the AWWA website, www.awwa.org.
To find out more about effective government in Illinois, check out our Taking Action blog series!
Paul May is currently the assistant executive director for a large public water agency which serves water to 500,000 consumers in the suburbs of Chicago. May is a licensed professional engineer and certified water operator, and is completing a master's in business administration this fall. May has a passion for water resources and has been honored to be a part of several advisory groups which have assisted in defining the direction for the future of water use in Northeastern Illinois.