By Jenny Bailey
Outsourcing is appealing to water utilities because they are natural monopolies. That is, by their nature there is limited ability for them to have competitors. It would clearly be inefficient to install multiple sets of water and sewer pipes to service properties – a high capital cost to deliver a low value product. In addition, elements of the service provided by water companies are a public good – something from which everyone gains a benefit and for which it is difficult for individuals to be charged. For example, the entire community gains benefits from the installation of a sewage treatment plant that prevents rivers and bays from becoming polluted.
Natural monopolies like water utilities use outsourcing to inject competition into their activities and thus improve efficiency. Private sector providers, such as metering businesses, are able to undertake functions more efficiently than the natural monopolies because:
- They are exposed to full competition, which leads to lower prices
- Economies of scale can be achieved by also servicing other utilities in other industries (meter reading is common across all utilities)
- A single focus enables specialisation – something that does not occur to the same extent when the function is one part of a business focused on other activities.
Another reason why outsourcing is useful for utilities is because it supports accountable organisational structures or cultures.
OUTSOURCING SUPPORTS ACCOUNTABLE ORGANISATIONAL CULTURES
Accountability is important to utilities, especially those that are natural monopolies, because it gives owners (often governments) and consumers confidence in the governance and efficiency of the organisation. In the developed world, governments generally require a high level of transparency and accountability from their owned entitities.
While there are many methods of instituting and demonstrating accountable practices, Yarra Valley Water (YVW), one of three retail water utilities servicing the region of Melbourne in southern Australia, has piloted an innovative approach in its Billing and Contact Services Group. As its name implies, this part of the business is responsible for YVW’s billing function and also its metering.
Believing that the conventional financial reporting approach to accountability does not necessarily result in a culture of accountability, the business group implemented an organisational model known as Requisite Organisation (RO). RO is based on decades of scientific work undertaken by social researcher Elliott Jacques, who studied the nature of organisational hierarchies. The basis of RO is shown in the box below, but an aspect is setting the pre-conditions which enable true accountability to flow through the organisation.
The implementation of RO has led to significant improvements in efficiency and customer outcomes in Yarra Valley Water. This is significant because many water utilities suffer from institutional arrangements that make it difficult to operate in accountable or ROs. Many are either governmentowned or heavily regulated, which means that they often have:
- Unclear accountabilities
- Unclear or conflicting organisational objectives
- Interference from third parties, such as government, ministers or unions.
Outsourcing supports an accountable culture because, as a result of letting a contract:
- Tasks must be clearly defined
- Conditions for completion of the task must be defined
- Accountability for doing the work is clear
- The contractor cannot be forced to take on addition work at the whim of someone without being paid for it, and
- The cost penalties for changing contracts are transparent.
Our experience at Yarra Valley Water is that outsourcing many aspects of the billing function and virtually all of the metering function has increased the rigour of the utility’s approach to accountability and has improved efficiency.
KEY POINTS IN REQUISITE ORGANISATION
Source: PeopleFit Australasia, Yarra Valley Water
At Yarra Valley Water, 58 percent of total operational expenditure and 99 percent of the capital expenditure is outsourced. The following are outsourced:
- Installation of new meters and meter fleet maintenance
- Meter reading
- Bill printing
- Billing system operations
- Debt collection
- Payment channels.
Customer contact is retained in-house, while the more routine aspects of metering and billing are outsourced. A look at the key criteria for choosing what can be outsourced shows why metering and billing are particularly suited to being outsourced.
WHAT SHOULD BE OUTSOURCED?
Simple repeatable tasks are most suitable for outsourcing. More complex tasks, where the contractor has significant discretion, make it very difficult to determine the quality of the work that is being delivered and what a suitable price would be. Because both metering and billing can be broken down into their component parts, they clearly fit the bill.
Secondly, it is important for the contracting organisation that there is a viable market for the activity that they wish to outsource. In some instances, if no such market exists, then consideration could be given to providing potential contractors access to intellectual property and training to enable them to build their competency for the tasks to be undertaken.
Another way of ensuring sufficient competition among contractors is to break down contracts into smaller component contracts to allow smaller companies to compete. This also allows them to build their capability, so you have several contractors to bid for work in future years.
KEY CRITERIA FOR SUCCESS
Success in outsourcing not only depends on what functions (or parts of functions) are chosen to be outsourced, but the preparation that precedes the letting of a contract. Desired outcomes must be able to be clearly articulated in terms of quantity (how much of what), quality (the attributes of what is to be delivered), time (when should the output be provided) and any resources to be provided by the company doing the outsourcing.
Preparing these specifications can be time consuming and may raise issues that need resolution before the work can be outsourced. Often there are broken business processes that need to be fixed. If they are not fixed first, then processes may be outsourced that are inherently inefficient. It is much harder to fix an outsourced process than to do so before the contract is let.
Other potential issues include technology and personnel. It is also necessary to decide the boundaries of the work i.e. how much discretion is left to the contractor. As an example, if a contractor is going to replace meters for you there are several options:
- You purchase meters for contractor to install
- You specify the exact meters to be used
- You specify criteria that any meter they use should meet
- You allow the contractor complete discretion.
General points The following points are important for outsourcing organisations.
- Accurately define the outcomes you want, but not how these should be achieved as this stifles the contractor’s ability to find more efficient and effective methods for undertaking the work
- Ensure appropriate risk allocation. Many people are tempted to outsource all of their risk to the contractor to make their life easier. However, this approach will only add costs, as any sensible contractor will price in the risk that he has to bear. Often the contractor is a much smaller company and a small increase in the price of materials may send him out of business, while it would be of little consequence to a utility. The most efficient outcome will be for the party that can best manage the risk to bear that risk. Inappropriate risk allocation will lead to unnecessary costs
- Ensure that your contract is legally sound. In successful outsourcing the contract does not need to be referred to much once it has been established, but if things start to go wrong the contract may be the only thing you have to rely on
- Ensure appropriate remedies for non-conformance. Remedies for non-conformance should be commensurate to the costs of managing non-conformance
- Appropriate incentives similarly matched to the value of the improvements to the company can significantly enhance outcomes
- It is essential to be able to build relationships (partnering). Successful outsourcing relies on building trust and good relationships
- A values match between organisations is essential to build the necessary trust and relationships
- Don’t make your supporting framework too large. Many companies outsource their operations but invest too heavily on monitoring the performance of the contractor and consequently do not achieve the desired efficiency savings.
RISKS ASSOCIATED WITH OUTSOURCING
- Legal, health and safety and environmental obligations cannot be outsourced
- Often there are significant cost savings upon letting a contract. However it is unlikely that you will get any further significant improvements once a tender is let
- Possible lack of flexibility. If circumstances change and you wish to undertake the work differently, this may be difficult depending upon your relationship with your contractor and penalties for termination
- Contractor is not making money. Driving a hard bargain when letting the contract will backfire if your contractor is not making money. The quality of the service that he provides may fall and if he goes bankrupt you may be left in a difficult situation in terms of getting the necessary work done when you no longer have the skills and resources.
CONTRACT MANAGEMENT SKILLS
- Do not skimp on contract management resources and capability. Often managing the contract is left to low-level staff in the organisation. A smart contractor will take advantage of this, which will cost more than you save
- Have a thorough understanding of the work being done on your behalf. Without this it is difficult to assess the quality of work that you are being provided with and hence whether you are getting value for money
- A basic understanding of contracts as legal documents is essential
- Have a win-win mentality. Many contract managers see their job as to ‘control’ the contractor and have a mindset that the contractor is out take advantage of them. In most instances, by working together good outcomes can be achieved by both parties
- Sound documentation is essential.