51: Main incentives
Contract management of water systems
The problem: efficient water supply
Many people think that water is a free good, which just falls from the sky. But in reality, water has to be collected, stored, conserved, purified, and transported; while wastewater has to be transported away, treated, and disposed of. And around these functions lies a whole set of business operations, including billing and metering.
Because water is heavy, it is hard to transport over long distances: so very commonly, local monopolies emerge in the supply of fresh water and the treatment of wastewater. Often, the local monopolist is the local government itself. So how can the water industry be kept efficient, if these local monopolies persist?
The solution: contract management
In the United Kingdom, the main regional water utilities, including the land and infrastructure they use, were completely privatized in the late 1980s (see the chapter Competition by Proxy). By contrast, municipalities and local authorities in France maintain the ultimate ownership of their water systems, but have for many years contracted out the management function to private companies.
Example: eaux concessionaire
In France, private-sector companies have gradually replaced local authorities as the operator of water supply and treatment services. Roughly three-quarters of the sector is now managed by private utilities. Two dominate the market: Vivendi Environment (which grew out of the well-known water company Generale des Eaux), and Suez Lyonaisse (formerly Lyonnais des Eaux).
These two groups have built a raft of commercial interests around the core business of water supply and treatment, and have a long history of doing so: Generale des Eaux, established in 1853, won its first public service concession to supply water in Lyons. It quickly won a series of other major contracts including one with the city of Paris in 1860. The first contract for wastewater treatment was signed with the city of Rheims in 1884.
This concession model of water supply and treatment has a long history in other countries too. General des Eaux exported its expertise to Italy, for example, when it won a contract to supply Venice in 1880. Ninety years later, it expanded into Spain and in 1986 it formed General Utilities to build up a portfolio of water (and other) businesses in the United Kingdom. In 1993 it became the main shareholder in AWT, which supplies water to New York City in the United States. In 1998, Vivendi, won the first build, operate and transfer (BOT) contract to build a water treatment plant in China. Indeed, around the world, Vivendi supplies 80 million people with drinking water, and has become the largest water utility in Europe.
In France, the company has over 4,000 contracts with local authorities and distributes water to 25 million people. It handles sewerage treatment for a further 16 million. Its joint venture with the Spanish utility Fomento de Construcciones y Contratas, FCC, has made it the largest waste management company and second largest water utility operating in Spain. The partnership has also put it in a powerful position to compete for contracts in South America.
Vivendi's great rival, Lyonnaise des Eaux, supplies 77 million people globally with drinking water, and handles wastewater services for 52 million. Its global interests include a number of contracts with city authorities in the United States where such public-private partnership,s are becoming increasingly popular. Its American subsidiary, United Water, recently won the largest-ever contract awarded for the supply of drinking water in Atlanta, Georgia. In the United Kingdom, Suez Lyonaisse owns the privatized Northumbrian Water and Essex & Suffolk, one of the former statutory water companies.
Other countries have transferred state-run water systems to private management. In Argentina, for example, Obras Sanitarias was sold to Aguas Argentinas, a subsidiary of Suez Lyonnaise, which expanded the water network to 600,000 new users, and agreed to cut prices by a quarter and invest US$4 billion in improving services. Australia has increased the private-sector role in water management, while in Canada, many municipalities have entered into partnerships with private-sector managers.
Assessment: competition on tap
Across the globe, the water supply market is becoming more competitive as new players are attracted into this expanding market. It is a growth business. What is more, the competitive approach based on fixed-term contracts is becoming increasingly popular throughout the world.
On the basis of their water supply and treatment businesses, French utility companies have diversified into linked businesses such as water-related construction projects, desalinization plants and water-related engineering projects around the world. In comparison with their British rivals, which were only privatized a decade previously, the French utilities have built up much broader capabilities and expertise.
The concession model may be easier to introduce than outright privatization. It does, however, have its limitations. Since fundamentally the model is just a concession to manage a state-owned local monopoly, there may be little need for concessionaires to innovate, as they would have to in a competitive, fully privatized market. Although there is a process of competitive tendering in the French model, the incumbent utility companies win the overwhelming number of franchise contract renewals. Incentive factors (such as how investment in infrastructure is treated when a contract ends and a new concessionaire takes over) can be important in making the process more or less truly competitive.
Nevertheless, there is a high degree of consumer satisfaction with the services provided by the private water operators in France: over 85% satisfaction, according to recent surveys.
It may be hard to introduce competition into the water sector, since so many parts of it are effectively a natural monopoly. However, it is certainly feasible. A true market may require the building of a water 'grid' network, so that supplies can be pumped from the cheapest suppliers to the driest areas which need those supplies the most; but such infrastructure is very expensive. On the other hand, it is easily possible to introduce competition into other parts of the business, such as metering and billing, emptying wastewater tanks, and so on. Arguably, the more that is transferred to real competition, the less worrying is the existence of any core monopoly.
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Copyright 2002: Adam Smith Institute
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