Why should I consider utility management outsourcing?

What utility functions can be outsourced?

If you had to summarize the benefits of outsourcing in one word, what would that be?

If I outsource my community's utilities, won't I lose control over them?

How can I be sure that a private operator will perform as expected over the long-term?

I hear many conflicting opinions about outsourcing.What are some of the myths and what are some of the realities?

Why shouldn't I simply let the public utility operators try to improve themselves rather than turning to outsourcing?

I've never done anything like this before. How do I go about it?

Why should I consider utility management outsourcing?

As a service delivery method, outsourcing can answer issues and needs in three key areas:

Utility Operations & Maintenance ("O&M"): A private firm can bring experience gained through years of operating numerous systems and technologies to bear in your community. Persistent difficulties in achieving compliance and in providing consistent, long-term, quality service can be permanently resolved by engaging such a contract operator. The day-to-day risks of operating in climates of increasingly stringent regulations and user demands for improved service, can be transferred to a private operator. As technologies become more sophisticated, operations become more complex, and the risk of non-compliance increases. In addition to assuring service quality and regulatory compliance, privatization will reduce O&M costs and help control future costs. Utility costs typically increase faster than general inflation, but cost guarantees from an experienced operator can help contain costs over time.

Utility Finances: Through a water or wastewater concession transaction, a community can realize immediate financial value from its utility assets. Most communities have invested substantial amounts of money in their water infrastructure over time. Through upfront lease or concession payments from a private operator, which reflect the present value of long-term savings from private operations, the community can create liquidity--generate cash--from its utilities. As an option, this liquidity can also be structured as cash flows over time, rather than or in addition to upfront payments. This new source of revenue can be used for further investment in environmental infrastructure, or other municipal needs. Concession arrangements can also provide off-balance sheet financing for utility needs. With the contractor financing improvements or expansions, communities do not need to further burden their general obligation balance sheet. Also, since most utility work can be financed with tax-exempt debt, whether governmental or private purpose, the cost of capital under privatization can be competitive with municipal financing.

Utility Management: The day-to-day management of utility systems has become a burden to most communities, draining professional and management resources that can be better focused on other municipal and community needs. Outsourcing provides a way for communities "to get out of the business" of utility management without giving up ownership, rate setting power, and capital improvement decision-making. In addition to direct cost, compliance, performance, and financial benefits, outsourcing utilities enables local leaders to concentrate their energies on other programs and functions. At least one headache--utility management--can be cured.

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What utility functions can be outsourced?

Contract operations and outsourcing approaches can be applied to virtually all utility functions. Beginning with the operation of treatment works, contracting can be extended to include management of collection and distribution systems, customer service, and activities such as:

  • Billing and collection
  • Fleet management
  • Capital improvement planning and implementation
  • New facilities design and construction
  • IPP implementation and management
  • Watershed development
  • Rate structure revision and implementation

An array of financial arrangements is also possible. Beginning with little or no funding or financial involvement by a contractor (for example, at the level of treatment works O&M only), outsourcing arrangements can be expanded to include:

  • The payment of concession fees
  • Lease rentals or annual royalties by the contractor
  • Debt defeasance and refinancing
  • Funding of major capital improvements for the utilities or other municipal projects
  • Creation of new revenue sources
  • The improvement of billing and collection practices and results

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If you had to summarize the benefits of outsourcing in one word, what would that be?

That one word would be guarantees. The essence of outsourcing is the provision of the type and breadth of guarantees that simply are not achievable under public operation and management. What are they?

  • Guaranteed operating budgets and costs, every year
  • Guaranteed system operations, regulatory compliance, service quality
  • Guaranteed construction costs and facility start-up schedules
  • Guaranteed customer service and response
  • Guaranteed revenues and revenue collection

The provision of guarantees is based on risk transference. Extracting guarantees from an operator means that the operator will be taking the risks associated with those elements: O&M costs, regulatory compliance, capital improvement implementation, inflation, and revenue flow.

The key to the guarantees is enforcement. Only through outsourcing can a community look to another party--the operator--rather than to its rate and tax payers to pay for the consequences of cost overruns, non-compliance, missed schedules, or poor revenue collections. Under continued public operation, the only recourse is to raise rates, pay fines, incur additional debt, and subsidize operations.

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If I outsource my community's utilities, won't I lose control over them?

The contrary is true. Outsourcing puts more control in your hands, not less. This is achieved through the execution of a contract between the community and its contractor, which gives you a single point of contact--the contractor--to resolve issues. The contract spells out, in detail, the operating requirements, standards, and parameters required of the operator. Under public operation, numerous steps may have to be taken before a problem can be solved: collective bargaining agreements, civil service regulations, operating protocols, numerous suppliers, governmental purchasing, and other policies and procedures. Under an outsourcing partnership, the contact is directly between you and the contractor, with the community directly instructing the operator on solving the problem. Issues that the contractor may face in order to solve the systems' problems--purchasing, labor, design, maintenance, repair, regulatory interface--remain with the contractor and do not become the problems of the community.

  • With outsourcing, the greatest powers remain in the hands of the community
  • Facility and system ownership
  • Rate setting and adjustment
  • Capital improvement decision-making

These options are never ceded to the operator.

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How can I be sure that a private operator will perform as expected over the long-term?

The key is selecting a capable and experienced contractor. Experience is defined by the extent of its history with utilities of similar size, scope, and complexity; similar technologies; and regulatory climate. Capability is based on its experience, its inventory of projects and systems, its client history, the history and capabilities of any parent companies or team members, and its staying power.

Performance assurance also comes through the terms and conditions of the contract with the operator. Contracts can and should be comprehensive and specific, and there are numerous models available. The best leave little to chance or misinterpretation. For example, they can be as detailed as in specifying the frequency of line cleaning or of generator testing, mandating emergency response times, defining what is a repair vs. what constitutes a capital improvement, establishing client inspection rights, and setting forth preventive maintenance requirements. The enforcement of such requirements is straightforward: the contractor's failure to observe them may constitute a breach and threaten penalties or termination. This threat is the greatest assurance of performance.

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I hear many conflicting opinions about outsourcing.
What are some of the myths and what are some of the realities?

Myth: A public/private partnership requires a long-term commitment by the community.

Reality: Outsourcing can be either short-term or long-term, depending upon the objectives of the community. Contract operations, particularly, can be short-term. Outsourcing that involves a financial element typically must be long-term but, termination and buy-out provisions can be negotiated.

 

Myth: The private operator will assume all risks.

Reality: No arrangement is risk-free. Outsourcing involves certain risks to the community, just as continued public operation involves risks. The difference with outsourcing is that substantially more risks can be transferred to the operator. Under public operation, the community bears all of the risks all of the time.

 

Myth: I should always aim for the lowest price.

Reality: The lowest price is not always the best deal. Outsourcing involves more than simply the price for service. It also entails elements such as the extent of guarantees provided, the degree of risk assumed by the private operator, and the capability of the operator to honor its commitments and obligations. As one example, what is the sense of dealing with the low-priced contractor if it cannot provide meaningful guarantees or performance security?

 

Myth: In order to maximize value I will need to sell my utilities, a step I am reluctant to take.

Reality: A number of leasing, concession, and public/private partnership models have evolved that enable a community to maximize financial value without selling assets. Transactions in communities such as North Brunswick, NJ; Cranston, RI; Wilmington, DE; Edison, NJ; and Taunton, MA are important examples of this. These projects have involved the payment of upfront concession/lease payments, the payment of annual "royalties," and the long-term guarantee of costs and user rates.

 

Myth: The impacts on labor are always negative.

Reality: When compared with the public sector, it is the U.S. privatization industry that is the place for employee training, development, and advancement. It is through the transition from public employment to the private sector that opportunities for continuing education, training, and career advancement are opened up. Most of U.S. Water's senior staff and line workforce, including its founder and president, came out of the public sector, working for municipalities and authorities before joining the company. A hallmark of U.S. Water's policies is continuing education, through on-going field training, classroom training, and tuition-reimbursed college-level education. Career advancement between projects and from the field into corporate positions is commonplace. When transitions to privatization involve staff reductions, these are typically handled through attrition, outplacement and retraining, or reassignment to other community or U.S. Water positions. Benefits packages can be tailored to meet specific local requirements, and to match those currently available to both unionized and nonunionized staffs.

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Why shouldn't I simply let the public utility operators try to improve themselves rather than turning to outsourcing?

Many communities explore this option, and it is a viable step to consider if you are confident that the utilities can be successful. Some questions you may want to ask are:

  • Even if some improvement can be made, what guarantees do you have that the improvements will be maintained over time and, in fact, further enhanced?

With outsourcing, this can be demanded of the contractor under the terms of its contract.

  • Can similar guarantees be extracted from the utilities, themselves, and if they can, what is standing behind the enforcement of the guarantees? Quick fixes may be possible, but can they be sustained?

Some communities are experimenting with "managed competition," putting their utilities in competition with private operators through a formal procurement process.

It is open to question whether managed competition can be fair:

  • Will the utilities be required to meet the same experience requirements as the private operators will be?
  • Will they be required to meet the same financial tests?
  • Post the same type of bid and performance security?
  • Bring off-balance sheet financing capability?
  • Provide the same level of enforceable guarantees?

If not, then a managed competition will be inherently inequitable and, in the end, may not serve the best interest of the community and its customers.

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I've never done anything like this before. How do I go about it?

There are four main steps you should take.

1. Determine your needs and objectives. This will require a very frank assessment of the condition of your utilities and what you hope to achieve through them. Experience has shown that a few objectives are virtually universal: reducing or stabilizing rates and costs, realizing the greatest value upfront; maximizing annual cash flows from operations, reducing the debt burden, protecting labor, and structuring off-balance sheet improvement financing. Some of these objectives may be contradictory and will require some tough choices: it may not be possible to extract the greatest financial value and, at the same time, reduce rates; it may not be able to realize significant cost reductions and, at the same time, protect labor entirely.

2. Review state enabling laws. Outsourcing can take many forms: short-term or long-term; with or without capital arrangements; with or without employee leasing; with or without facilities construction. To a major degree, the format you adopt will be determined by what state enabling laws will allow. As an example, New Jersey has a very hospitable legislative climate and enables virtually all forms of outsourcing and contracting out. In other states, the climate is either less enabling or less clear. Depending upon the scope of your project, it may be necessary to pursue special legislation. However, as, for example, several communities in Massachusetts have learned, this step is usually worth the effort.

3. Structure a fair and reasonable procurement. There are numerous RFP and process models available and a community of experienced advisors who can assist in designing and managing your procurement. The best models:

  • State specific goals and objectives, while at the same time welcome alternatives and options
  • Furnish complete and accurate information and data
  • Grant reasonable response times
  • Provide good and repeated access for facility tours and information gathering
  • Require relevant and measurable project experience and financial criteria
  • Impose contract terms and conditions that reflect customary industry standards

4. Negotiate in good faith. Outsourcing procurements are unlike most municipal purchasing, in that contracts generally do not need to be (and should not be) awarded on a low-bid basis. Most elements of a contract are subject to negotiation, from costs and user rates to the extent of guarantees provided by the contractor. Both sides in the negotiations are looking to build a positive relationship based upon the provision of services over time rather than the one-time supplying of goods and materials. Negotiations should be aimed at achieving a win-win situation, under which the major objectives of both can be satisfied and both will benefit mutually. Both sides will be called on to give up and compromise, in the interest of the relationship. Also, both will be called upon to live up to contractual obligations over the term of the contract. It is not as simple as the contractor supplying a piece of equipment and the municipality paying for it and taking possession. The real work of the partnership begins with contract signing.

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