Wanting To Increase Your Fixed Revenue Does Not Make You A Bad Person
by Kirk Stinchcombe
March 28, 2019
I spend a lot of time talking to municipal CFOs and Public Works Directors all over North America. I hear all the time that people are increasingly concerned about revenue stability from year to year, and with good reason. Customers continue to install more efficient toilets and clothes washers. They are also using less water on their lawns and gardens. Per capita demand continues to go down in most communities, typically by 1% to 2% each year.
All else being equal, this means that variable rates — the portion of a resident’s bill that goes up and down depending on how much water they use — put downward pressure on revenues and require rate increases to offset them. If people use less water, you have less revenue. The math is straightforward, but the politics are usually anything but — it’s just very difficult to continuously go back to the well for increases that may be perceived by rate payers as gouging (even if peoples’ total bills may not be changing that much). Having more fixed revenue mitigates this problem.
For the past nine years, I’ve had the great privilege of serving on the Board of Directors for the Alliance for Water Efficiency. It may be heresy for a director of North America’s leading advocate for water efficiency to do this, but I’m going to give you some advice if you are thinking about reducing the variable portion of your rate structure in order address revenue stability.
Yes, I know: reducing your variable component will give people less incentive to use water wisely, and could lead to demand increases. As well, variable rates are usually fairer. They give customers more control over their bills and, since higher income people tend to use more water, variable charges are typically easier on low income families.
Some of my colleagues will disagree with me (see this blog post from Janice Beecher of the Institute of Public Utilities for a very thoughtful alternative perspective), but I still think it is OK to contemplate shifting some water rate revenue from variable to fixed charges as long as you take a balanced approach. I have a few suggestions on how to go about it.
1. Understand Your Goals – When we set water rates, we are actually setting community policy. How we go about charging people for water services has various implications for community, environmental and financial sustainability. There are difficult trade-offs between conservation, fairness and revenue stability. Being clear and transparent about this and what you want to achieve at the outset will help you decide how far to go and allow you to communicate more effectively with elected officials and the public when presenting a proposed rate change.
2. Set Boundaries – Once you have thought through your policy goals, having an understanding of where demand (and therefore variable revenue) is tracking is important. We know it is probably going to continue to trend down, but it is also going to vary from year to year with variation in weather. Waterworth has about two dozen different tools to help you look at water use trends year-over-year. We’re also more than happy to give you some advice on how to best predict future changes in your financial module. Planning from a starting point of assuming declining per capita demand means you are far less likely to be surprised down the road when it inevitably happens.
The Alliance for Water Efficiency is headquartered in Chicago and is a stakeholder-based non-profit organization dedicated to the efficient and sustainable use of water in North America.
I know I’m biased, but in recent years, AWE has produced what I think are some of the best publicly available materials out there on water rate management through its Financing Sustainable Water website. They have some fantastic resources, including tips on how to set rates, advice on communicating with residents, and some pretty handy modeling tools. All free and well worth a look.
3. Keep a Balance – You can go too far with putting too much of your charges into the fixed component. Yes, it makes things easier from a revenue forecasting point of view, but the risk is that you will completely swamp the price signal that variable components sent to consumers, washing away any incentive to use the service efficiently. Mary Ann Dickenson, my friend and CEO of the Alliance for Water Efficiency, suggests that the fixed portion should not exceed 30 or 40% of an average total bill, and I think that is a pretty good benchmark to start from.
4. Look at the Rate Structure Itself – Rather than simply reducing the variable portion of the bill, you can also look at how the rate structure itself works towards achieving your policy goals. For example, if you want to keep things simple but also give people incentive to conserve year round, a uniform structure with a base charge makes good sense (that is, the amount that people pay per gallon or litre stays the same no matter how much they use). On the other hand, if controlling peak demand in the summer is a priority, then a tiered rate structure may be the way to go (that is, with charges per unit increasing as customers pass different consumption thresholds in a billing period). A seasonal surcharge is another obvious though rarely used option. This is an extra volume-based charge that is introduced in the summer months only, when most irrigation and other discretionary demand occurs. There’s a lot to say about this topic, so I’ll return to it in a future blog post.
5. Build a Rate Stabilization Fund – this one might seem impractical to those of you who are struggling just to maintain basic operating reserves, but remember that Rome was not built in a day. An alternative to reducing the fixed component of the bill while still maintaining revenue stability is to have a reserve fund that you can tap into in years where consumption is lower. For example, you might do this in a year with unusually wet conditions during peak irrigation season. In years where demand is higher, you replenish the fund. Waterworth has tools to help you examine various reserve fund options. You can play with different scenarios that build reserves up over a few years and see what this does to revenue requirements.
In sum, there are numerous options to stabilize revenue, but you need to start with understanding your objectives and what your rate structure currently does for you. Waterworth users can do this easily with the new suite of rate calculator tools that we’re releasing this quarter. Give JP and the Waterworth customer success team a call and we’ll be happy to give you some ideas of how to approach this.
I’ll stand by my claim that I don’t think increasing the fixed portion of your customers’ water bills makes you an environmental criminal. With some careful planning and attention to the rate structure, this might be one of those few times when you can have your cake (water conservation and fairness) and eat it too (stable revenue year over year).