PPP Development Stage – Financing (Cost Recovery)
13.2 What are the key processes?
The key processes for cost recovery include:
- 1. establishing a cost recovery strategy;
- 2. tariffs and charges structuring;
- 3. subsidising; and
- 4. billing and collection.
1. Establishing a cost recovery strategy
PPPs can play an important role in reaching cost recovery
goals. They open up avenues of communication that help solve
the problems that often arise during infrastructure projects.
They also make a wider range of solutions available and can help
ensure wider support for the projects and cost recovery objectives.
Projects that are successful at achieving their cost recovery
goals have adopted several different types of strategies.
These strategies relate to many aspects of the project, such
- tariff and fee structure, for example, targeted subsidies
or a low rate for the first block of water used;
- forming an appropriate and feasible payment scheme;
- designing appropriate payment options;
- billing, charging and payment, for example, change the frequency
of payments, improve the billing system and delivery,
increase or change payment points or work with a community group to collect money;
- customer relations/education;
- rewards and punishments, for example, random prize draws for
houses that pay or service cut-off for non-payment;
- community mobilisation and participation or communal billing.
The delineation between these strategies is not always
clear and in many cases they overlap – for example,
working with or establishing community
institutions can help with both education and better bill
2. Tariff structuring
A "tariff" means a service charge that the municipality
charges for the use of services. Tariff structuring depends on
many factors, thus it is not possible to make “one size fits
The process of tariff structuring is important in the promotion
of the sector reform process. The main objectives of tariff
- to recover the cost of service supplying;
- to ensure efficient use of services by consumers; and
- to ensure access of all groups to basic minimum service needs.
Basic types of water tariff structures
a) Single-part tariff (single-tariff pricing)
- a method of pricing that consolidates rates across multiple
service territories owned and operated by a multi-system
utility that may or may not be contiguous or physically
interconnected. Also known as “consolidated rates”.
A single-part tariff consists of either:
- 1. A fixed charge – the monthly water
bill is independent of the volume consumed (not based on measured
water use); or
- 2. A volumetric charge – this charge
is made for the volume of water, which is measured through a supply
point. It may be:
– a uniform price volumetric tariff
– all units of water are billed at the same price;
– an increasing linear tariff – unit charge increases linearly
as water use increases;
– block-type structures – two or more prices, each applies to use
within a defined segment (block) of monthly use. Unit charge is constant over
a specified range of water use and then shifts as use increases; or
– decreasing block pricing (or declining-block pricing) – a pricing
structure in which both the average and marginal price per unit decreases as
b) Two-part tariffs
- a pricing technique in which users pay a fixed sum for access
to a service and pay another charge for each unit of the
service they consume. The charge per unit may vary, making
the system a multi-part tariff.
Tariffs can be differentiated by type of user (residential
or commercial, industry or tourism, for instance.)
In developing the tariff structure, municipalities and their
advisors will need to consider the factors that will affect
implementation. These may include:
- the failure to link tariff regimes to productivity and
thus ensure private sector incentives;
- the low metering levels in poor areas – thus undermining
the “user pays” principle;
- the distortions that pro-poor tariff structures produce in
the market incentives for the private operator; and
- the lack of a clear mechanism for tariff setting and revision.
However, government finance may be necessary in many developing
countries, where users cannot afford the full
costs of the necessary infrastructure programmes.
Many projects around the world never recover all costs. In
fact, it is only in some western countries that customers
(rather than ”beneficiaries”) of an infrastructure service
pay completely for the service they get, be it directly or indirectly
In most developing countries there will be a conflict if
sound financial arrangements are to mean both full cost
recovery and equity. In such a case targeted subsidies are
necessary from the rich to the poor who cannot afford service
Accurate information on the costs of supplying a service
and information on the patterns of service demand, are
both critical for decision-making process. With this information
decision makers then need to decide:
- what they prioritise for subsidy;
- what element/stage/aspect of the service to subsidise;
- how the subsidy should be delivered; and
- who the recipients of the subsidy should be.
Subsidies generally come in two forms:
The financing mechanism used to cover the
shortfall in supply costs by the injection of finance from outside
the sector or industry. Examples of direct subsidies include the
widespread financing of solid waste services or donor support
to governments that are undergoing sectoral reform.
The main advantages of direct subsidies are that they
are transparent, explicit, and minimise distortions in
the behaviour of water utilities and their customers. The main
drawbacks of direct subsidies are the difficulty of defining
suitable eligibility criteria as well as the administrative
cost entailed in identifying eligible households.
A mechanism to cover costs by shifting the burden from one
consumer group to another within that sector or industry.
For example, the costs of delivery are significantly higher
in the more remote, less concentrated areas; alternatively,
high-consumption users pay a higher unit rate than low-consumption
Cross-subsidy of the poor (by charging richer users more)
is commonly regarded as a desirable objective of water systems.
This may involve cross-subsidies between different social,
economic or regional groups of users. The most common method
of doing this is through some form of stepped “block” tariff,
which is usually intended to reduce the cost of water for poorer households.
This can include a “lifeline” element of free water, the cost of
which is covered by higher charges elsewhere. Another simple form of cross-subsidy
within a given service is a “solidarity charge”, whereby affluent
users, or those with their own connection, pay a supplement designed to cover
the cost of supplying water to poorer users.
4. Billing and collection
The collection of payments due from users is important to balance
income and expenditure and achieve the financial plan. Failure
to collect all charges due from users is a common reason
for financial deficits – increasing collection rates is a
simple method of restoring profitability.
This is usually the most significant change introduced by
private companies. It is a technically and managerially
simple process to create a comprehensive and up-to-date database
of users, and to then issue invoices for the amounts owed.
Identification of the constraints to the effective collection
As a part of the tariff policy structuring, municipalities
should explore the factors affecting payment and, where possible,
design mechanisms to address constraints. Analysis should
identify the reasons for low-cost recovery and the constraints
affecting service provision and access.
In order to establish the level of service demand, it is necessary
to know what are the needs of the urban poor and how those
needs can be better served. Experience shows that the poor
must become participant in (rather than beneficiaries of) the
process, and that development processes must be designed with flexibility
to ensure that participation can be achieved. The participation
of poor communities is essential to ensure efficacy and
sustainability in project ends, and to maximise the benefits
of project means.
Partnership and service delivery incentives should respond
to the demands of the poor, adapt to different levels of
demand within a community and should provide different
levels of service or means of payment.
Affordability and willingness to pay
Affordability and willingness to pay studies are a crucial
stage of the partnership development and should be carried
out in the context of a broader livelihood analysis.
A qualitative and quantitative poverty assessment should expose
how much the poor currently pay for service provision. Such
an assessment should also reveal the following:
- the source of the service and the service alternatives
currently available to poor households;
- the frequency of payment, the flexibility of payment conditions
and the options available in a time of crisis;
- the percentage of households’ incomes spent on each service
and the opportunity cost of that expenditure;
- how many of the poor can be categorised as being “able
to pay”, how this could defined, the trends among different
poor groups, the differences between willingness to pay
and having no choice but to pay and the links between affordability
and other characteristics; and
- The factors affecting service affordability (seasonal unemployment,
flooding, sickness, marriage and so on).
Raising tariffs to cost-reflective levels might have a disproportionate
impact on the real income of the poor, for whom water comprises
a larger share of their consumption “basket” than
it does for the non-poor. This, in turn, may serve as a pretext
for mobilising political opposition to tariff reform.
It is necessary to recognise that there is a great diversity
in the capability, vulnerability and capacity of low-income
groups. Urban areas, communities, neighbourhoods, households
and individuals experience different levels of poverty
and are affected in very different ways. Various poverty assessments
show that a significant difference between the poorest
urban dwellers and their slightly-less poor and better-off poor
neighbours lies in the way households prioritise service
needs and fund service expenditure. Poor people develop complex
strategies to ensure their survival in a crisis, or simply to cope
with seasonal variations in their poverty. In particular, poor
households make economies by cutting down on education, health
care, food and cutting back on the utilisation of services. Thus
cost recovery will increase and decrease in relation to these factors
and livelihood assets.