Rate setting for water, sewer and other utilities is a mystery to many people. It drives others crazy! Rate increases make some people so angry that the word angry doesn't begin to describe how they feel. Bad rate setting gets some local government elected officials voted out of office. No rate setting leaving rates where they have been for years has set thousands of utilities up for some serious hard times or even failure.
It's no wonder utility decision-makers fear adjusting rates. They fear even bringing the topic up.
Fear no more (well, maybe just a little.) You can get great rates and keep your job or elected position, your sanity and your friends. Don't laugh. This is not a ?get great rates quick' scheme. It's a ?get great rates the right way' scheme.
Great rates do two things:
- They adequately fill all the short and longer-term needs of the system,
- They treat ratepayers fairly.
What great rates do is very simple. But, getting such rates is going to take some time and work, forever. While the process is never-ending, it is easy to spell out and most of it is (relatively) easy to do.
Rate setting works best when done in four phases:
- Phase 1 Decide your rate and fee goals your destination.
- Phase 2 Develop a comprehensive rate analysis your road map that leads to your goals, usually requiring large initial rate adjustments and rate structure changes.
- Phase 3 Adjust rates and fees get started on your journey using the analysis to inform your decisions.
- Phase 4 Make incremental rate adjustments in future years course corrections that are almost always increases to keep net revenues and other financial indicators on track with the projections from the comprehensive rate analysis.
Utilities range in size and complexity but all need to do rate setting through these four phases. To be clear, all systems need to do Phases 1, 3 and 4 themselves. You can get advice on these phases but do-it-yourself is the only choice for getting them done. For the Phase 2 comprehensive rate analysis, you get to decide if you will do your own or if you will hire it done. However you get it done, just make sure this analysis is a good one because for a long time you will be basing everything you do on it.
Rate Setting by the Numbers
Phase 1 Set Goals
Choosing 'great rates' is usually a no-brainer for the author. (There are actually circumstances when you DON'T want great rates, but that is another, very special story.) Making the great rates decision is not that easy for communities. Many decisions you make about other things will impact your rates. And, decisions that you make about your rates will impact many things. It's a Rubik's cube, a giant brain teaser. If you want to have 'great rates,' you have to solve this puzzle and set goals first. While that is easy to say, it may take many months for you to objectively arrive at rate and utility system goals.
While a Phase 2 comprehensive rate analysis will help you to refine your rate and system goals, don't put off setting goals hoping that the analysis will solve this puzzle for you. The author has deep experience in doing rate analyses for communities that haven't set their goals yet. Invariably they want yet another rate scenario run, hoping that last scenario will look so good to everyone that they can live happily ever after paying those rates. It just doesn't turn out that way.
While a rate setting expert can help you weigh rate and system goal options, each community must settle upon its own goals. Once that is done, you need an expertly done rate analysis.
Phase 2 Analyze Rates
A comprehensive rate analysis mathematically solves three questions:
- Where are we?
- Where do we want to be?
- How do we get there?
You may have a feel for the answer to the question, Where are we ' You probably can sense that your financial condition is bad or headed south. However, you probably don't know just how bad it really is. By the time most systems decide they need a comprehensive rate analysis they need an average initial rate increase of 20 to 45 percent. They also need severe rate restructuring to make their rates fair. The comprehensive rate analysis will answer the Where are we ' question in explicit financial detail.
You have already answered, at least generally, the Where do we want to be ' question when you set goals. You did set goals, didn't you The analysis will put some numbers to the choices you have already made. Those numbers might even convince you to decide differently and change your goals, funding plans, capital improvement plans or something else. Most systems find that, while their rates are too low right now, with reasonable adjustments they can actually afford to do much more than they thought they could.
Finally, your rate analysis will answer the How do we get there ' question. It will show you exactly how to adjust your rates, fees, policies and ordinances. It will show you how to plan for future equipment replacements and capital improvements. And, your analyst will guide you in how to sell the proposed rates to your ratepayers.
The Phase 2 analysis is especially focused on the initial adjustments, that ever-popular, and likely 20 to 45 percent rate increase.
But, the analysis will also peer into the future and tell you what kinds of rate adjustments, usually inflationary increases, you will need to make for perhaps the next 10 years to sustain the pursuit of your goals.
Now that you have your goals solidified and the analysis to tell you how to reach your goals, it's time to do something about it.
Phase 3 Adjust Rates
This is, of course, a political process and politics has a pretty bad reputation. However, you can gain ratepayer acceptance of your rate adjustment proposal by doing two things:
- Get a Phase 2 comprehensive rate analysis, and make it clear to all that the analysis was sound and not influenced by politics.
- Make it clear that the elected officials actually did or will use the results of the analysis to inform their rate adjustment decisions.
There are many ins and outs to making rate adjustments. Some are technical, like making sure your ordinance will pass legal muster. Some are pure politics, in the best sense of the term. You are trying to do a good thing for your ratepayers; set rates that will enable.
THEIR utility to provide the service THEY desire. You need to convince most of your ratepayers, who are cool-headed but usually disengaged from system decision-making, that the proposed rates will be fair and affordable and they will enable good service. You also need to convince your CAVE people not to organize the cool-heads to oppose you.
There are many issues to cover and excellent strategies you can use to keep the cool-heads with you and the CAVE people from opposing you in any organized fashion. Your rate setting specialist can give you guidance on these.
Going into a board or council meeting to consider rate adjustments is like going into battle. If you have not been getting or doing Phase 2 comprehensive rate analyses, then you have been going into battle without air support, artillery support, or even a walky-talky. You have been battered and bruised. You may have even assumed your current position because your predecessor didn't survive the previous unsupported battle or they went AWOL to escape it.
Because Phase 3 rate adjustments are supported by a Phase 2 comprehensive analysis, you will have cover for your rate setting decisions. Many times the enemy (not your cool-headed ratepayers because they will be with you, but the CAVE people) won't even contest this battle. So, take heart that this battle can be won, probably handily. That will set you up for lots of wins in the future. That is what Phase 4 is all about.
Phase 4 Adjust Rates Again and Again, Incrementally
Incremental rate increases are those done during years in-between comprehensive rate analyses. These are small, simple inflationary increases made to allow revenues to keep track with costs as they rise with inflation. Like regular brushing and flossing, these increases are a do-it-yourself affair. They do not take rate structure fairness into account. However, since they are small increases done following soon after a rate restructuring, rates will remain fair enough for several years to come.
Successful rate resetting is like a marathon. There are times during a marathon when you need to sprint. (For older marathoners like the author, sprinting is a relative term.) When you're in the crowd you sometimes need to sprint to avoid a crash. If you are so blessed to be that fast, you may find yourself nearing the finish line near the lead. You need to sprint and lean into the finish line tape if you want to win. However, most of the time the marathon is run at a fairly steady and relatively comfortable pace cruising. In rate setting, you should only do a Phase 2 analysis and Phase 3 rate adjustment sprint infrequently. You need to do Phase 4 rate increases every year cruise to keep on pace.
Phase 4 increases are pretty easy to sell because they are almost always small. This is how you do it.
Your board or council needs to revisit the rates once a year. To do that they need to look at what the previous Phase 2 comprehensive analysis predicted for this year and compare it to the system's current financial position and other indicators. Then, one of three things should happen:
- If the predicted and current financial positions match closely, and if future needs are like those anticipated in the analysis, the board or council should increase rates by the factors recommended in the analysis. This is a slam-dunk easy adjustment.
- If the two diverge modestly, the board or council should adopt rates that will get the system back on track. They can do that with some simple math. This is only slightly more complex than a slam-dunk.
- If the predicted financial performance diverges wildly from the actual, a simple math calculation won't do. It's time for a new comprehensive analysis. The analysis is complex but the board or council's part is still easy to do.
Because these adjustments are small, few if any of your ratepayers will drag themselves away from everything else they have going on to concentrate on these adjustments. For such things they are willing to just let you take care of business.
In the author's experience, many systems can go about five years between comprehensive analyses by making incremental increases each year.
Conclusion
You want to take your system and your customers to a destination great rates and great service. You decide that destination by setting goals in Phase 1. Then you need a map, a Phase 2 comprehensive analysis, if you hope to find your destination. You can't reach any destination without starting. Phase 3 rate setting gets you on your way. Once you have arrived at your destination you can't stay there without paying the costs you will incur in the future. Incremental rate increases, Phase 4, will keep you where you want to be.
Author Bio and Contact Information
Carl Brown is President of Carl Brown Consulting, LLC ; specializing in water and sewer system rate analysis and rate setting, asset management program development and training nationwide.
Mr. Brown may be contacted at Carl Brown Consulting, LLC , 1014 Carousel Drive , Jefferson City , Missouri , 65101 , Phone (573) 619-3411, E-mail carlbrown@mchsi.com. Web site: www.carlbrownconsulting.com.
