Erythropoietin (EPO) is a hormone produced by the kidney that promotes and stimulates the formation of red blood cells by the bone marrow. The resulting rise in red cells increases the oxygen-carrying capacity of the blood. We as people need oxygen. We as athletes (yes, I still considered myself an athlete, though I manage to run only 20 miles per week) need a lot of oxygen! What a great thing this EPO is: if we get a little more in our organism, we can break out of our physical limits! With greater efficiency! And a lot of athletes seem to think in the same way!
Now, can you imagine having a performance-enhancer for development projects? Of course, also in this case we would need a fancy acronym, which is something the international community is very good in providing. In fact, there are quite a few already available, including: RBF (results based financing); P4P (payment for performance); PBF (performance based financing), which in turns inject oxygen into innovative contracting modalities, such as PBC (performance based contracting) and OBC (Output-based contract). See GPOBA for More & Juicy Acronyms – M&JA!
In a few words, RBF is a financing mechanism that, within a given timeframe, links (at least a part of the) payments, and/or subsidies to the achievement of previously determined performance targets, outputs or outcomes. Yes, you can call this a paradigm shift (oh how I love this expression), since traditional contracts used in the water and sanitation sector tend to focus more on inputs or the contractor’s responsibilities (e.g. to build a treatment plant) rather than outputs or outcomes related to operational and/or financial performance (e.g. volumes of treated water). As the International Water Association teaches us, key features that differentiate PBCs from more traditional service contracts include:
- Higher value for money – the performance risk lies with the contractor and full remuneration is contingent upon verifiable improvements to performance or service levels.
- Greater flexibility for the contractor – PBC is not prescriptive. The contractor decides which measures to undertake in order to achieve its targets, leaving room for possible creative solutions and innovation.
- Fairer risk allocation – The performance and reputational risk is distributed based on local circumstances, and is reflected in the payment mechanism.
To date, PBCs for targeted service contracts have been used mostly for reducing levels of non-revenue water (NRW). And this is exactly what happened in the Bahamas, where with an eye on the goal of making its water supply system more efficient, the Bahamas Water and Sewerage Corporation (WSC) embarked in an ambitious program funded by an Inter-American Development Bank (IDB) to address the problem of non-revenue water and fix the relationship between the utility and its customers, which had been deteriorating during the years.
For three decades, WSC had been trying to provide New Providence’s 250,000 residents with reliable quality service but with limited success. In 2012, with about 58% of the water entered into the utility’s distribution system lost before reaching customers, WSC determined that only an integrated, comprehensive approach could solve these problems – through a PBC. The project needed some additional EPO. That is how a PBC was signed with an international group, linking a portion of the remuneration to the NRW level in time.
Preliminary results from the program are incredibly encouraging. Sales are set to increase and water into supply is going down. Eureka! (More blogs will follow!)
The bad news is: injecting additional EPO in the system is dangerous (and illegal)! Bugger. Too bad. The reason that EPO is dangerous is because of increased blood viscosity. Above a certain hematocrit level whole blood can sludge and clog capillaries, compromising our capacity to function and causing strokes and heart attacks.
From a similar (though indisputably stretched) perspective, results-based finance cannot be considered a panacea for the water sector. PBC can indeed help a utility to aim for higher service levels and increase operational efficiency; as long as some key factors within the contract are carefully pondered and analyzed, including:
- Structuring remuneration, which usually combines fixed payments with variable payments, since a full transfer of risk to the contractor (e.g. through 100% variable remuneration) is unrealistic. But how much should be the fixed payment? How shall the fixed payment include “unknown” factors that could affect the achievement of the targets? Together with quantifiable the targets, the contract must clearly spell out the expected inputs tied to the fixed payment. Which is not as straightforward as it sounds!
- Risk allocation, which should take into consideration elements of both the country and the utility context (quality of available information, governance issues, and expectations for utility staff collaboration, among others). But how to estimate that? Hard negotiations are expected!
- Baseline date and setting targets. This is the core of the contract: where do we start from and where do we want to reach. The data provided at inception by the utility must be reliable. An independent, third party may also be employed to verify it. At the same time, performance targets must be set, balancing (a) ‘achievability’ with (b) being ambitious. Again, not that easy.
The preliminary results from Bahamas are very encouraging. This can indeed become an interesting successful case study for the future.
However, even with a solid contract, efficiency gains achieved through PBCs will only be maintained through an appropriate institutional and governance structure that promotes transparency and accountability. So many things to consider with PBF! And we thought it was as easy as getting some additional EPO in the system?! Any cycler who can assist us? (O.U.C.H.!)