Jeff Hughes is a Director of the School of Government’s Environmental Finance Center and a School of Government Faculty Member
Fixed costs vs. variable costs. Fundamental concepts for any business owner concerned with developing accurate business plans, financial models, and pricing strategies. The way in which these basic business concepts take shape for most water and wastewater utilities have made life very difficult for utility managers over the last few years as falling water sales due to customer conservation and industrial downsizing have demonstrated the degree to which most community water and wastewater enterprises are fixed price businesses. In other words, their costs remain relatively constant regardless of how much water they produce and sell. This fact becomes obvious after examining many of the major cost components of utilities: debt service, staffing costs of maintaining sufficient work crews to maintain infrastructure, and billing/customer service costs. Several years ago, the City of Charlotte calculated the fixed and variable components of their revenues and their costs and showed that over 80% of their revenue depended directly on the amount of water they sold while less than 10% of their costs (primarily electricity and chemicals) varied directly with water sales. The result of this paradox – selling 15% less water due to customer savings may reduce revenue by close to 15% but will a neglible impact on costs. Many customers make the completely inaccurate assumption that since they are charged $3.50 per thousand gallons of water, their utility immediately saves $3.50 if they buy a thousand gallons less. What does this mean for the future of a business where all signs are that costs (both fixed and variable) are going up and sales are relatively flat or decreasing? The financial reality is that at least in the short run in most situations consumers will pay more per unit of water even if the reductions are due to customer stewardship and conservation. Paying more for less volume is a difficult concept to convey under any circumstances, but it is especially difficult if customers and community leaders are not aware of the cost realities behind utilities. Future posts will focus on innovative strategies that utilities across the state have begun using to address this uncomfortable reality.