In this video, I want you to think about some of the challenges of public private partnerships from the perspective of the private operator. I want you to imagine that you are working for a private operator that has just signed a concession contract to manage a poorly performing public water utility in a low income country. Suppose that you have been appointed as a senior manager in charge of this concession. The public utility has all the problems that we discussed in our 2014 part I MOOC, high unaccounted for water, low levels of cost recovery, overstaffed bureaucracy, low moral, poor bill collection. Assume you do not know the condition of much of the pipe infrastructure. In fact, you may not even know the pipes are located. The maps maybe missing or they may never have existed. As the manager of this new concession, where do you begin? What do you do first? You might imagine that you would want to raise tariffs, but this is probably not your first priority. I'll tell you a story I heard from my friend John Briscoe, the former senior water adviser at the World Bank who passed away in 2014. John was the winner of the 2014 Stockholm water prize which is informally known as the noble prize for water. John said that a French water executive told him the story, I don't know if it's true but it has the ring of truth. A senior executive in a private French water firm was advising a young French manager who was about to depart to takeover the management of a water system in a moderate sized French city. The senior executive told the young manager to be careful with the tariff. He said, don't charge too much. Of course he said, the firm wants a good rate of return on investment. But tariffs were very sensitive politically. And it was important that the French water firm not be perceived by customers as too greedy. The senior manager's point was that any possible extra profits were not worth the risk and trouble that the higher prices might create. The senior manager clearly knew something about ancient instincts about water. So if your top priority is not a tariff increase, what would it be? The private operator's primary focus will be on generating positive cash flow. How can this be done? Let's go back to basics. The private operator will want to increase revenues and reduce cost. Of course, in the medium to long term, the costs include capital cost, but in the short term, the private operator will focus on reducing operating cost and not incurring capital cost. The private operator wants to see a steady and increasing stream of revenues from the customers' water bills flowing into its bank account. The fastest and politically safest way to increase revenues is not to increase prices but to increase bill collection. So the first priority is to collect customers' water bills. If the system has a private meter connection, this in tails focusing on efficient accurate meter reading, timely preparation and delivery of water bills and enforcement. Enforcement need not be heavy handed. Disconnecting customers maybe necessary as a last resort, but it is a political mind field. Recall the video on the dangers of the African water hall and the ancient instinct about being denied access to water. Enforcement may simply mean convincing households of the importance of everyone paying their water bill, so that the company can provide high quality service. The best strategy may be to try to make payments the social norm. Then households that don't pay will feel social pressure if they do not pay their fair share of the cost of providing their community with high quality services. Private operators may want to facilitate ways for customers to pay their water bills such as electronic payment. Another top priority for a new private operator is to improve the electronic billing system to ensure that water bills can be issued promptly and accurately. Another priority is usually getting meters installed on unmetered connections. This actually addresses two problems. First, it will usually increase revenues. And second, equally importantly, installing meters will control cost by reducing water use. If costumers with unmetered connections are selling water to neighbors or to vendors, this can be a large source of essentially non revenue water. A top priority of the private operator will be plugging such revenue holes. Next on the list of priorities is controlling leakage and unaccounted for water. This is effectively a focus on reducing costs. Incurring the cost of producing treated water without receiving any revenues obviously negatively affects cash flow. Some leaks are easy and cheap to fix, others may not be financially worthwhile. But this analysis of the cost and benefits of projects to reduce non-revenue water and leakage would be a high priority for a new private operator. An important aspect of this is reducing the number of illegal connections. So to summarize, so far, the private operator's top priorities are collection of water bills, electronics software and customer billing system. And non revenue water and illegal connections. What about tariffs? If tariffs are far below cost, which as we have seen is typically the case, a private operator will obviously want tariffs increased. But the private operator does not want to be blamed for or associated with rapid tariff increases just after the change from public to private management. The ideal solution for the private operators to have the public water utility raised tariffs before the change in management regime. The proponents of public private partnerships often engage in a number of activities prior to the privatization deal to make this transaction more attractive to private operators who may be considering bidding for the contract. Proponents want more parties bidding, so the price is set competitively and is as low as possible. In other words, the success of the bidding process depends in part on there being multiple independent parties bidding for the contract. One of the fears proponents of privatization had before some of the early privatization deals was that no one would actually bid for the contract. Tariff increases are the top of the list of things to do to make the transaction more attractive to private parties. For example, the Chinese government often has followed this strategy, has been quite aggressive in increasing tariffs before privatization initiatives. This strategy of getting tariffs raised in advance may conflict with a strategy of bidders offering a low tariff to win a contract. In an environment with a weak regulator, there has been a worry that a private company may offer unrealistically low tariffs as part of a bid in hopes of winning the contract. Then after winning the contract, it will be able to convince the regulator to increase tariffs. I understand this risk but if I were a private operator bidding for a contract, this would seem like a pretty risky strategy to me. because, I've emphasized the political economy of water tariffs is very emotional. I would be concerned about the negative reaction of both civil society and the regulator. For this strategy to work, both civil society and the regulator have to not object to the rate increase. There's another way to make the transaction more attractive to a private operator. Reduce the number of employees working for the public water utility before the privatization. Over time, many public water utilities have increased the number of their staff far beyond what is required for efficient operations. A private operator needs to reduce labor cost to increase cash flow. But finding a politically acceptable way to do this is often challenging. But essential to making the politics or the privatization deal work, the World Bank has financed optional retirement packages for water utility employees as part of the financing of some public private partnerships. The private company Manilla Water offers an attractive example of how to retain staff. The company offered to train many staff members of the public sector utility with new skills needed and then hire them as employees. We will return to the topic of the regulation of private operators in later videos. What I want you to remember from this video is that a private operator faces a number of strategic decisions about how to increase cash flow. What a private operator will try hard to avoid is investing its own capital in the deal. To meet the service obligation specified in the contract, the private operator will need to make capital investments. Most private operators will try to fund these at a cash flow, not by the parent company taking on new debt or investing its own capital. This is somewhat ironic, because one of the big hopes of the proponents of engaging the private sector in the municipal water supply business was that this would provide cities with the capital required to build and expand the water supply system. But from my perspective, this was largely wishful thinking. These systems were too capital intensive and the regulatory and political environment too risky for private operators to bring new capital to the table. A much more sensible strategy was to finance investments out of cash flow. Whether or not this will be feasible, was often difficult to the private operator to determine in advance, there were several reasons for this. First, the physical condition of the existing assets was difficult to determine. Second, the cost of the service obligations and the contract were hard to estimate. And third, the actions of the regulator and central government were hard to predict. If you were a shareholder in a private company operating a water concession, would you want the company to put its own capital at risk, building new infrastructure? Or would you prefer to finance investments out of cash flow? In the next video, we'll look at some of the empirical evidence on how well privatization contracts have worked in practice.