A Wastewater Treatment Privatization Case Study: Indianapolis, Indiana

Craig Golding
March 8, 2000

Introduction

The story of privatization in Indianapolis begins with Mayor Stephen Goldsmith. He ran on a privatization platform in the 1992 election, which he won. Reforms started shortly thereafter, and by 1993, his administration was looking into competitive bidding for the two Advanced Wastewater Treatment (AWT) facilities that served the city.(1) By February 1999, privatization of the AWT facilities had generated over $72 million in savings.(2) The Indianapolis wastewater privatization – the largest project of its type at the time it was undertaken – is frequently touted as an example of successful privatization. This case study will examine the privatization process and its outcome. It will focus on the problems sometimes associated with privatization, with the goal of providing insight into their significance in a wastewater contracting situation.

Before analysing Indianapolis’s experience, it is wise to present a snapshot of the national state of affairs in the privatization of municipal services. Privatization is not new to services such as refuse collection, snow removal, street repair or even drinking water provision. Although it is not as great, the rate of wastewater treatment privatization is now increasing.(3) Whereas the U.S. federal government previously supplied much of the funding for wastewater services, the 1980s and 1990s brought a reduction in the supply of federal funds. At the same time, the federal Environmental Protection Agency (EPA) was introducing increasingly stringent environmental standards. These forces put pressure on many municipalities to find efficiency gains in these services.

Public ownership with private management, as opposed to pure public or private ownership, is becoming popular in the United States. The tax-exempt status of government debt creates a strong incentive to use public capital instead of private financing; contracting is frequently chosen as a vehicle for privatization for this reason. Before 1997, tax laws converted tax-free debt into taxable debt if municipalities sold their facilities or contracted out operations for a period of more than five years.(4) Also in the event of long-term contracting, leases or sales of facilities, federal tax laws required that all federal grants be repaid.(5) Indianapolis chose contracting over an outright sale because of these financial biases against private financing. The city investigated the possibility of selling the plants but could not do so because construction had been financed by government grants and tax-exempt bonds.(6) According to Skip Stitt, the former deputy mayor who oversaw the process, Indianapolis would have lost money if it had chosen to sell its facilities.(7)

Private provision of public services is not new to Indianapolis. Drinking water has been supplied by a private company for over 120 years.(8) This history of private participation makes the Goldsmith administration’s introduction of privatization – or as it likes to stress, competition – seem less radical. The privatization process was doubtless both politically and economically motivated. The city faced a $1-billion infrastructure deficit, $500 million in sewer improvements, pension and economic development liabilities plus a mayor who pledged never to raise sewerage fees or property taxes.(9) Mayor Goldsmith believed that his city could cut costs by introducing competition for the provision of public services. He created the Office of Enterprise Development (OED), a control centre for privatization initiatives, and the Service, Efficiency, and Lower Taxes for Indianapolis Commission (SELTIC), a group of professionals who would lend their expertise to the effort. SELTIC helped OED design procedures to be followed when contracting.(10) Of the 66 services that had been put out to tender up to 1996, 37 were awarded to private companies. Unions won 20 of the 29 services they bid on, and some services were split between the two sectors. Private sector bidders generally won the larger competitions.(11) Most of the $150-million savings attributable to competition since 1992 have been used for public safety and infrastructure projects.(12)

The Privatization Process

Indianapolis’s two AWT facilities (Belmont and Southport) were identified as a potential source of savings. The facilities have a 250-million-gallon-per-day (MGD) combined capacity, with an average daily flow of 190 MGD, and serve a population of 800,000.(13) The two AWT facilities were rebuilt in 1983 at a cost of $250 million.(14) At the time of privatization, both plants were considered well run, having received several American Metropolitan Sewage Association (AMSA) medals for meeting effluent standards in the preceding years.(15) There are no awards given for efficient performance however. The city spent a considerable $30.1 million a year on the AWT facilities before contracting began.(16)

Indianapolis was the first major U.S. city to contract operations of wastewater facilities, and as such it proceeded carefully.(17) The city spent 18 months researching the plan and conducting technical and financial investigations. It hired the engineering consulting firm Camp, Dresser and McKee to perform a technical evaluation of the plants and the consulting firm Ernst and Young to study the various management options. The latter concluded that savings of five percent could be achieved by contracting.(18) The administration was sceptical of this report, believing that it could achieve something better, and took steps toward contracting.

The bidding process was open to practically any firm that felt it had a legitimate chance to win and to the city workers. Realizing that existing city employees had no experience with competitive bidding, the city appointed a consultant to work with them on their bid. Seven firms responded to the request for qualifications, and the city requested proposals from five of them.(19) As part of the bidding process, the city sent its proposed capital plan to the finalists and asked them to comment on it, indicating what was necessary and what could be omitted or delayed. This was done in response to expressed concerns that private firms would boost capital spending, which was scheduled to remain a city responsibility, in order to lessen the maintenance expenditures, which were to be assigned to the winning vendor. Contrary to these fears, the potential operators indicated that the plan could be curtailed with no impact on environmental quality or expenses. (20)

Eventually, the decision came down to a choice between the White River Environmental Partnership, Professional Services Group Inc. and Advanced Water Treatment, the latter consisting of existing AWT staff.(21) By all accounts, the range of the private sector bids was small and the margins were quite narrow.(22) Each private firm promised savings of approximately $65 million. In contrast, Advanced Water Treatment proposed cutting costs by $12 million over five years, with staff reductions to be achieved through attrition only.(23) The city chose the White River Environmental Partnership (WREP), a consortium consisting of IWC Resources, Inc., the parent company to the Indianapolis Water Company (52 percent); JMM Operational Services, now called United Water Services, a wholly owned subsidiary of United Water Resources (43 percent); and a multinational water corporation, Suez Lyonnaise des Eaux (SLDE) (five percent).(24) The Indianapolis Water Company has provided drinking water to the city for over 100 years. SLDE brought considerable technological sophistication to the new entity. Together, they offered a combination of local knowledge and technical expertise at the right price. The contract to operate and maintain the two wastewater treatment plants was signed in late 1993, and WREP took over operations on January 31, 1994.

Although critics of privatization frequently raise concerns about corruption, bidding laws and access to information, Indianapolis seemed to provide sufficient transparency. “Every document we generate in connection with one of these transactions ultimately is a public document,” said former deputy mayor Stitt.(25) There was some concern that several 1995 amendments to state laws restricting release of information during negotiations would allow for collusion between city staff and potential bidders in succeeding competitions. According to Mr. Stitt, the laws were amended because the immediate release of proposals made it difficult to negotiate additional savings. When vendors know the next highest bid, they are in a better bargaining position. With the amendments, documents are released after the contracts have been awarded.(26)

The signing of the contract created a need for contract monitoring. This responsibility was given to the Department of Public Works (DPW). In the mid-1990s, the Contract Compliance Division was established to oversee all the contracts administered by the DPW, of which the wastewater contract was the most significant. Some environmental monitoring is provided by the DPW’s Environmental Resource Management Division, while further testing is done by the Indiana Department of Environmental Management (IDEM). EPA standards such as the National Pollutant Discharge Elimination System permits are administered by the IDEM. In a procedure referred to as split sampling, an independent, private company periodically tests AWT effluent, and results are compared with those reported by the contractor for the same effluent sample.(27) Furthermore, two advisory panels were created at the time of contracting. The AWT Advisory Group, consisting of academics and industrial and environmental stakeholders, evaluates technical operation of the plants. The Environmental Overview Task Force, more of an environmental watchdog, includes most of the significant environmental groups in the region and addresses issues of environmental concern. WREP sends representatives to meetings of both groups.(28)

The Contract

As economist Randall G. Holcombe, among others, has established, contract design is critical to the success of a privatization effort. Dr. Holcombe illustrated the importance of careful contracting by showing what can happen when it is done poorly.(29) Primarily concerned with efficiency issues, and with broadly defining cost savings, he demonstrated that a contract that delivers cost savings but increases the city’s exposure to risk might not actually save money when all costs and benefits are taken into account. Recent anecdotal evidence seems to indicate that concerns over contracts that fail to transfer responsibilities are unfounded. According to Mr. Stitt, typical transactions in the U.S. – including the Indianapolis AWT contract – transfer the risk of environmental non-compliance and financial guarantees to the contractors.(30) Many jurisdictions are more concerned that contracts address the issue of job losses. Typically in the U.S., protecting jobs is simply a given in a privatization.(31) Service vendors are reluctant to cut staff and expect that they will be responsible for management of the natural attrition process. In fact, they want to do it well because they know that success in this area increases their chances of winning contracts in other cities.(32) The success of the privatization efforts in Indianapolis and elsewhere, measured by risk transferred, employment controversy avoided, savings generated or environmental goals achieved, depends upon the contract between the parties. Indianapolis’s clear, well-defined contract for AWT operations is the key to the effectiveness of the entire process.

The original contract for operations of the AWT facilities had a duration of five years, from January 31, 1994, to December 31, 1998. City administrators were pleased with the results and signed a 10-year extension in October 1997. WREP also won the contract for sewer system operations and maintenance in 1996. The city is guaranteed savings of $250 million over the duration of all three contracts (sewers, original AWT and extension), which run until December 2007.(33) WREP received a $14.4-million-a-year annual fee under the original contract. The city retained responsibility for maintenance costs, which totalled about $3 million a year.(34) Under the new contract, compensation is also based on an annual fee, with modifications for maintenance, consulting and capital investment costs, as well as an adjustment for inflation. The 1999 base portion of the annual fee is $15,360,481. The 2000 base annual fee is $15,441,006. Base fees are indexed according to a complicated formula stipulated in the contract, but they essentially follow inflation. WREP receives additional compensation for assistance with capital improvements planning. Payments for these services range between $180,000 and $300,000 annually.(35) The third avenue of compensation is described in Section 8.07 of the contract, titled Additional Services.(36) Additional services include any services provided to the city by WREP that are not called for in the contract. They are billed at cost plus 14 percent.

The assignment of risk is an integral part of any contract. It is important to have clearly defined responsibilities, and that has been achieved with this contract. WREP and the city seem to have found an equitable division of responsibilities. In instances involving harm resulting from wilful or negligent acts on the part of WREP employees, WREP is to indemnify the city from all liability.(37) Furthermore, according to Section 15.03 of the contract, WREP is liable for all fines and penalties resulting from such mishaps.(38) In fact, WREP is protected from liability only when the city has refused to fund capital repairs that are necessary to maintain the effective operations of the plants. Sections 6.06 and 6.07 indicate that WREP must comply with all laws, including applicable environmental laws. Risks arising from changes in treatment processes are the responsibility of WREP, but the savings arising from these changes are to be shared equally with the city.(39) The city protects itself from risk and preserves incentives for innovation by this sharing of savings.

There is some risk associated with WREP’s switching the AWT effluent treatment processes from ozonization to chlorination. Section 6.19 of the contract, Dechlorination, sets out the pertinent responsibilities. It stipulates that if a regulatory body bans chlorination, WREP alone will be responsible for expenses associated with meeting any new regulations. Furthermore, the city does not pay for chemicals used in the liquid dechlorination program, although the annual fee includes $200,000 for costs related to chlorination/dechlorination. If this process is abandoned, the annual fee will be changed to reflect this and the cost of any replacement processes.(40) Finally, WREP is responsible for all insurance and must either buy it on the commercial market or self-insure. The contract stipulates that the contractor must possess liability, vehicular and excess liability insurance.(41)

One of the primary concerns with private operations and maintenance of public assets is the role of profits in the equation and, specifically, how the desire for profits may affect dedication to service quality. In the wastewater treatment field, quality is measured by the cleanliness of the effluent. The city’s lawyers must ensure that private operators are not boosting profits by cutting corners in maintenance of the facilities and allowing the infrastructure to degenerate. These issues are addressed in the contract between the City of Indianapolis and WREP. Provisions for quality control, wherein WREP is made responsible for all environmental compliance, are cited above. Provisions for adequate maintenance are more involved, reflecting the complexity of the issue. At a basic level, WREP is contractually obligated to maintain the facilities at a level comparable to or better than that maintained by the city prior to contracting.(42) According to Mr. Stitt, the contractors aim to improve maintenance measures, such as vibration analysis, year after year. In this way, they will be able to meet their commitment to return the facilities in the same or better condition.

WREP is responsible for funding routine maintenance and operations.(43) Administrators in Indianapolis have chosen to deal with the potential problem of underinvestment in major maintenance by retaining funding responsibilities in-house. That is, the city is responsible for funding all, and approving some, infrastructure expenditures. This is done by a series of funds. WREP draws on the funds to pay for maintenance as it sees fit, with surplus funds going back to the city. The Minor Corrective Maintenance Fund (MiCMF) is provided for necessary funding of repairs and minor corrective maintenance (costing less than $25,000) and other non-repetitive, non-routine maintenance activities. The MiCMF is not to be used for routine, preventive and predictive maintenance, which WREP is supposed to pay, nor shall WREP aggregate items to turn them into a major corrective maintenance project.(44) The annual MiCMF is in the amount of $1.5 million, payable to WREP in monthly instalments.

Sections 6.22 and 7.04 of the contract detail the city’s major capital funding obligations. WREP and the city work together to come up with a Capital Improvement Plan on an ongoing basis. If the city and WREP cannot agree on a plan, WREP is indemnified from any damages suffered as a result of the capital deficiencies. The city funds major capital improvements (costing more than $75,000) up to $3 million per year.(45) There is no corresponding fund for WREP to draw on as it does for maintenance. Section 7.04 details procedures for minor capital improvements (less than $75,000 per year) and major corrective maintenance (more than $25,000 per year). These two types of improvements are administered through another fund that is similar to the MiCMF but is instead dedicated to capital improvements and larger maintenance projects. The Minor Capital Improvements and Major Corrective Maintenance Fund (MCI/MaCMF) totals $2 million per year, payable in monthly instalments. Authors such as Daniel Mullins and C. Kurt Zorn have expressed concerns about this type of maintenance and capital funding scheme, correctly surmising that it creates inefficient incentives.(46) When the need for maintenance or capital expenditures is low, excess spending may result. When the need for such expenditures is great, the contractor may put things off. The contractor can spend the $2 million in the MCI/MaCMF at its discretion, provided that the individual projects require less than $10,000; city approval is needed for capital projects that individually exceed $10,000 in value. In fact, the contractor gets reimbursed at cost plus 11 percent for all labour costs, materials, subcontracting and so on.(47) As a result, there may be an incentive for overspending and overcapitalization. Indianapolis may have overcorrected in response to concerns that operations and maintenance contracts may lower incentives for maintenance and capital expenditures.(48) It seems that Indianapolis believes overspending to be the lesser of two evils. It may not be the best or only solution to the problem, but it is one that the administrators were willing to live with.

Informational and monitoring concerns have always attended privatization schemes. Information can relate to anything from monitoring effluent quality to informational asymmetries that may affect future bids. The contract between the city and WREP has been designed to account for many of these issues. Section 11.02, Access to the AWT Facilities, stipulates that agents of the city are to have access to the facilities at any time and they can expect WREP’s full cooperation.(49) WREP is required to produce monthly environmental compliance reports, and the city’s Contract Compliance Division takes split samples of effluent several times a year. The contract authors anticipated the problems associated with a possible change of contractors and included a clause that requires WREP to do everything possible, including sharing non-proprietary information, to make such a transfer seamless. At termination of the agreement, there should be an orderly transition, uninterrupted provision of services and compliance with reasonable requests and requirements of the city in connection with such termination.(50) Thanks to these measures, the city is now receiving more information on the status of the facilities than it did prior to privatization.(51) In an effort to further address information and monitoring concerns relating to environmental quality and facilities maintenance, the city added the expertise of two independent engineering firms to that of its in-house investigators in 1996. Together, they monitor the effectiveness of the contract provisions for operations and capital expenditures.(52)

Article XII of the contract deals with dispute resolution. In the event of a disagreement, the first option is for the parties to attempt to resolve disputes in good faith. If matters are not resolved within 60 days of the initial notice, either party may initiate mediation in accordance with Rule 2 of the Indiana Rules of Alternative Dispute Resolution. When and if disputes arise, mediation and other dispute resolution mechanisms limit the cost of resolving the unforseen issues. The city may seek injunctions when it perceives a threat of irreparable harm.(53) In even more extreme circumstances, the city can seek immediate termination of the contract. Section 3.02 states that the city may terminate the agreement at any time giving 90 days notice and having just cause.(54) Article X, Defaults and Remedies, further provides that WREP can get out of the contract if the city fails to make a monthly payment and goes into default for more than 90 days. In the very worst circumstances, if WREP engages in gross misconduct, then the city can walk right in, take over and bill the firm for the expense.

Labour Issues

The introduction of contracting elicited resistance from both unions and environmental groups. Unionized employees were worried that layoffs would follow any contracting of the AWT facilities’ operations. Environmentalists were worried about possible environmental quality impacts. In retrospect, most of those involved agree that the privatization of the AWT facilities has worked out very well and that the majority of the problems that led to the initial resistance were caused by a lack of communication between the unions, environmentalists, the private operator and the city.(55) To wit, public meetings were held only after the contract was signed.(56)

When the contract with WREP was announced, the affected union – the American Federation of State, County and Municipal Employees (AFSCME) – was so vehemently opposed to it that it launched a court suit to stop it. The union’s initial concerns were understandable. The contract requires WREP to maintain staffing levels adequate for safe and effective operation of the plants, but exact levels are not specified.(57) As a result, WREP was free to reduce staff levels from 328 in 1993 to 196 in 1994 and eventually down to 157 persons in 1998.(58) Of the workers displaced in 1994, few were left unemployed: 67 went elsewhere in city government operations (the city had banked positions in anticipation), 43 found other jobs through a $300,000 outplacement system funded by WREP, 10 got other jobs on their own, and five retired.(59) Section 9.02, Personnel Changes by Contractor, states that WREP, if it decides to further reduce staff, must make its best effort to place affected employees in similar positions with WREP or its parent companies.(60) Section 9.01, Comparable Employment, requires WREP to offer compensation packages equal to or better than those offered under city management.(61) Compensation packages have actually been enhanced for those who remain. They receive higher salaries, increased benefits and more training than they did under city management.(62) In its 1998 five-year summary of activities, WREP proclaims that “[p]ay incentives exist for enhanced certification levels, and employee-nominated awards provide additional cash incentives. An independent analysis of overall compensation and benefits shows WREP employees currently to be between 9 and 28 percent ahead of their city counterparts.”(63)

Other measures of worker satisfaction also point to success. Grievances fell from 39 in 1993 to an average of 0.4 from 1994 through 1998, and the average annual number of employee accidents is down over 84 percent over the course of the contract.(64) Safety advances led to lower workmen’s compensation insurance rates, which fell eight percent.(65) A federal task force studying labour-management relations in municipalities cited Indianapolis as a model of cooperation. The Secretary of Labor’s Task Force on Excellence in State and Local Government Through Labor-Management Cooperation delivered its report in May 1996, proclaiming that “Indianapolis presents a comprehensive example of how a municipal government accrued tremendous benefits through labor-management cooperation.”(66)

Although the unions in the city still do not officially support privatization, spokespersons do admit that the privatization of the AWT facilities has improved the lot of their members. According to Steve Quick, the president of the AFSCME union local, “[m]ore individual opportunities for training and advancement exist under WREP’s management structure, plus employees respect the safer environment.”(67) WREP worked conscientiously to foster a positive relationship with the unions. The partnership became one of the first private companies to sign a bargaining agreement with AFSCME.(68) In perhaps the most illustrative testament to the strength of the bond between staff and WREP administration, the union chose to partner with WREP on the winning bid for the sewage collection system contract in 1995.(69) Steven Cohen and William Eimicke reported that after three years, labour relations were better than ever.(70) Former local AFSCME President Stephen Fantauzzo said that many former city workers would not consider returning to city employment, such is their pleasure with the new arrangement.(71)

Mr. Quick attributes Indianapolis’s success to the efforts of Mayor Goldsmith. When asked if he could recommend privatization for other districts, he replied that he could not, because other jurisdictions do not have the same leadership. “Mayor Goldsmith was a visionary,” he said, “he got input from the unions.(72) There is no rhetoric with him; he empowered the unions.” Mr. Quick went on to cite the fact that Mayor Goldsmith acted in good faith in agreeing to reduce overhead by cutting excess management staff in the wastewater treatment division. This was done in an effort to make it possible for the city employees to enter a competitive bid. He advised other mayors considering privatization to show the unions they care about the fate of the workers. “The mayor must build trust,” maintained Mr. Quick. “In Indianapolis, they built that trust.”(73)

Environmental Performance

The privatization of sewage treatment has similarly won the approval of area environmentalists. Local environmental groups were intent on ensuring that the quality of services did not decline as a result of privatization. Diminished environmental quality could have negated any gains achieved from cost saving measures. Fortunately, wastewater treatment has a definite output that is easily measurable. The contractor ensures its accountability by opening its doors to city, state and private monitors who, along with WREP staff, provide monthly performance reports, quarterly performance updates and annual city audits that validate equipment condition.(74) Overall, WREP has improved upon the level of service that was provided under in-house management, with violations of water quality standards falling 86 percent.(75) Most recent figures indicate that WREP is exceeding goals established by the city in all measurement categories. WREP exceeded the city’s targets in overall treatment efficiency, biological oxygen demand, total suspended solids and ammonia concentrations in 1998. As of June 1999, it was on its way to repeating this performance.(76) Even in the face of increasing flows and increasing pollutant levels, the plants maintained a pollutant discharge level averaging less than one half the limits established by the EPA.(77) Independent organizations have also praised the work of WREP. In 1997, the American Metropolitan Sewage Association (AMSA) presented a platinum award to the Southport plant honouring five consecutive years of perfect compliance with EPA discharge permits.(78) This followed the presentation of six gold awards – each marking a year’s perfect compliance with discharge permits – to the two plants operated by WREP since 1994.(79) The Indiana Department of Environmental Management awarded the Belmont plant its highest rating in September 1998, with inspections based on effluent quality, upkeep, maintenance practices and cleanliness of facilities.(80)

Local environmental groups have also given WREP high marks.(81) Representatives of many of these groups currently sit on the Environmental Overview Task Force that acts as WREP’s environmental watchdog. The private operators have little opportunity to hide any wrongdoing and, evidently, have had little reason to do so. All of the environmentalists contacted agreed that the performance of WREP has surpassed that of the city. Richard Van Frank, the Audubon Society member of the Environmental Overview Task Force, said that “[s]ince the AWT plants have been privatized the operation and maintenance have improved.”(82) Brant Cowser, a member of Friends of the White River (FOWR), also had praise for WREP, citing a solid working relationship, trust and good communication through the environmental task force. “I and FOWR believe that contracting the AWT was a good move for our city. We have been very successful with the past four years,” he wrote.(83)

The majority of those environmentalists contacted do not approve of the switch from ozonization to chlorination, favouring instead ultraviolet radiation (UV) to treat the AWT effluent. According to Lou Ann Baker, Manager of Communications at WREP, the switch to chlorine was intended to be temporary. She claims that the switch was necessary because the ozonization system suffered too many breakdowns, was expensive to operate and could not handle wet weather events, leading to permit violations. A more environmentally friendly disinfection system using UV light is currently under development with help from one of WREP’s parent companies, Suez Lyonnaise des Eaux, and Purdue University researchers. According to the contractor, it is now up to the city to determine when replacement systems will be installed. Although WREP has recommended installing a UV system, the city has thus far chosen to stick with the chlorination system. Glenn Pratt, a civil engineer and former EPA employee who provides technical assistance to FOWR and who sits on both the environmental and technical advisory panels, says that the city, which is responsible for funding all capital improvements, is merely avoiding the short-term costs of UV installation. In the end, UV costs compare favourably with those for chlorination/dechlorination.(84) Perhaps this can be seen as an example of the short-term planning horizons that are particular to governments that can only see as far as the next election. No matter the reason, environmentalists agree that continued use of chlorination should not be blamed on privatization.

Indianapolis, despite the performance of the AWT facilities, has had difficulties dealing with combined sewer overflows (CSOs). In autumn 1994, CSOs from the Indianapolis system caused two massive fish kills (affecting more than 500,000 fish) in the White River. WREP’s competitors pointed to the disasters in efforts to sully the company’s reputation.(85) Mayor Goldsmith’s political opponents also got some mileage out of the fish kill controversy. Criticisms were misguided however, as the CSOs had more to do with the city-owned and -maintained (at the time) wastewater collection system than with the privately operated treatment plants. Kyle Niederpruem of the Indianapolis Star/News reported that “[s]tate environmental regulators found no violations of the plant’s permit, a legal limit set for polluting discharges into the water. . . . Combined sewer overflows historically have been allowed to legally spill into Hoosier waterways and have not been a part of discharges measured by permits.” The Indiana Department of Natural Resources went so far as to write a letter that exonerated WREP and praised its attempts to meet difficult environmental challenges.(86) In the ensuing years, WREP worked with the city to avoid similar disasters. For example, WREP found a way to avoid one billion gallons of CSO in 1998 by converting old preaeration tanks at the Belmont plant into primary clarification tanks, improving its ability to process flows during wet weather.(87)

Cost Savings

The ultimate goal of the privatization of the wastewater facilities in Indianapolis was, simply, to save money. As a result, the success of the entire process will be measured primarily by the cost savings achieved. Savings over the first five years were initially projected at $65 million.(88) The city spent $30.1 million in 1993. In 1994, city officials budgeted $19.3 million, but WREP only charged the city $17.6 million for services rendered, creating first-year savings of over 41 percent.(89) Savings over the first 23 months were $21,683,876 ($58,233,563 projected budget for in-house operations versus $36,549,687 for the contract), equalling a 37 percent reduction.(90) The 1998 revised operating budget for the AWT facilities was $22,401,334, a decrease of approximately one-tenth of one percent from 1997.(91) The 1999 revised operating budget was $22,515,841 and the proposed budget for 2000 is $24,283,592. In short, although costs are increasing, the city continues to spend far less than it had prior to contracting.(92) As of February 1999, the city had saved $72.8 million on the AWT contract, including $63.1 million on operations and maintenance costs and $9.7 million in avoided capital expenditures.(93) A 10-year extension was signed in 1997, with projected additional savings (comparing costs to those under city management) of $189 million.(94) With the extension and the contract for sewer maintenance included, savings are projected to total $250 million over the life of the contracts.(95) Without considering hidden costs such as transaction costs, the privatization of wastewater facilities in Indianapolis has delivered savings on the order of 40 percent.

Given that Indianapolis has achieved such significant savings by contracting for wastewater treatment, the source of the savings merits investigation. At the time the agreement was announced, Patrick Cairo, the project director, expected savings to come from the use of technology that was previously unavailable to the city.(96) The director of Public Works agreed. “It’s just a different league. [The French] firms have resources our guys only dream of.”(97) In the end, it seems that savings have come from a variety of sources: Economies of scale allow for wholesale purchase agreements; expertise and efficient processes are shared with WREP’s parent companies and their subsidiaries; WREP has improved the planning of maintenance and capital expenditures; and as discussed above, WREP has dramatically reduced staff.(98) Process savings can be further broken down into utility costs, which fell by 20 percent, corrective maintenance, which fell by 30 percent, and unanticipated capital expenditures, which were down by 20 percent by the time WREP issued its second annual report in January 1996.(99) WREP claims that corrective maintenance has been minimized by an increased focus on preventive and predictive maintenance, which is more cost effective and reduces downtime for existing equipment.(100) Between 1993 and 1998, WREP achieved $12 million in savings on the capital improvement program through more integrated planning of projects.(101) Indianapolis also achieved capital savings by showing the proposed capital plan to the bidders, all of whom recommended a 10 to 15 percent decrease, saying that the excess added no value. Thus, in addition to operations and maintenance savings, the city achieved capital savings without giving up control of the asset. This was achieved despite the commonly held belief that contracting companies prefer newer equipment to old, the former being cheaper to maintain.(102) In other areas, WREP cut the number of warehouses from 37 to 2, decreased inventory from $6.7 million to $2 million and increased revenue from private sewage haulers by nearly 300 percent, with revenues being split evenly with the city.(103) The private firm also reduced fleet costs through preventive maintenance and use of outside contractors.(104)

Some critics, specifically Profs. Mullins and Zorn, argue that some cost savings are due to the switch from ozonization to chlorination and cannot be attributed to privatization in itself.(105) The city was spending $1.2 million a year on an unsuccessful campaign to keep the ozonization system running; WREP therefore generated $6 million in savings just by abandoning costly repairs to the ozonization system.(106) Regardless, these savings must be attributable to the privatization because the city had not taken advantage of them, despite the fact that it had had every opportunity to do so in the years prior to contracting. Imprudent dedication to a costly, ineffective and frequently inoperable treatment process is an example of the sort of failure to which public organizations are susceptible. Private firms, with every incentive to cut costs, don’t stand for this sort of behaviour; the White River Environmental Partnership provides an excellent example of this.

Finally, we can investigate what Indianapolis did with its savings in order to more fully understand the benefits of the privatization process. Savings helped the city avoid a sewer rate increase. Rates have remained steady at an average of $7.71 per month per household from 1985 through August 1999.(107) By issuing debt against the savings stream from all of its privatization efforts, Indianapolis was able to fund an infrastructure improvements program called Building Better Neighbourhoods (BBN). Improvements worth approximately $1 billion have been implemented over the last seven years.(108) This program includes sewer repairs, $144 million worth of which were required as of 1991.(109) Thirty million dollars of wastewater treatment savings were directed toward BBN and capital improvements. Another $16 million were directed toward debt service (presumably the debt issued against the savings) and fund balancing (transfers to other financial reserves).(110) It would appear that the savings were so great that they allowed administrators to shift money from water users to relieve taxpayers in a sort of cross-subsidization. In a recent press release, the city stated that these savings have helped keep taxes low and the city financially healthy. Twenty million dollars were transferred for payment in lieu of taxes from the sanitary fund – which holds excess sewerage funds – into the public safety pension fund for police and firefighters.(111)

Despite the outstanding nature of the savings, the question of transaction costs remains. As Profs. Mullins and Zorn observe, when the city and WREP mention their costs savings, they do not include contracting or monitoring costs. Ignoring these costs can lead to overestimation of cost savings from privatization.(112) Although monitoring costs would have been incurred under city ownership, and therefore should not be considered, contracting costs are indeed a concern. The city spent over $900,000 on contracting costs.(113) Lou Ann Baker of WREP indicated that although she was not sure exactly how much her firm spent to secure the contract, she estimated that it could not have exceeded $400,000. Adding this to the $300,000 WREP spent on employee transition costs and to the city’s contracting costs, transaction costs totalled $1.6 million, an insignificant figure in the face of savings that are already 45 times larger and are projected to be over 100 times larger. Even if this analysis of transaction costs is optimistic, and the costs were actually twice those stated, they would still pale in the face of the considerable savings WREP has managed to generate. As Mr. Stitt noted, dollars spent securing this transaction were earned back by savings generated in the first 10 days. The facts indicate that, in Indianapolis, transaction costs did not offset the benefits of privatization.

Conclusion

Indianapolis provides a solid example of how a government can make use of the private sector to provide a service more efficiently than is possible in the public sector. The city has saved over $70 million in the first five years alone, with transaction costs having little impact on aggregate benefits. Notwithstanding initial staff reductions, remaining employees are now better off than they were before the advent of contracting. The environment is also better off, as WREP has managed to improve on the city’s already impressive compliance record. Risk transfer, a key to true efficiency gains, is complete and equitable, with the vendor accepting full responsibility for its performance, both environmental and otherwise. The city takes no responsibility for processes that are beyond its control. The parties established concrete standards for asset maintenance, and the contract sets out a mechanism for checking the performance of the contractor. Those who created the contract have defrayed potential court costs by including provisions for independent arbitration in the event of disagreements. The thorny issue of asset maintenance is the one area that the city has not completely resolved. By establishing maintenance and capital improvements funds, the city ensured that WREP has no incentives to allow the infrastructure to degenerate. However, WREP does have an incentive to overspend on these needs. With this one exception, the contract is designed such that WREP has every incentive to operate the plants safely, cheaply and efficiently, and the firm has done just that over the first five years of contracting. Indianapolis’s wastewater treatment privatization should provide a valuable role model for other cities facing mounting fiscal and environmental pressures. In 1998, Messrs. Cohen and Eimicke predicted that “[i]n Indianapolis, it appears that the wisdom of the entrepreneurial decision to contract out will withstand both economic and environmental questioning.”(114) The evidence indicates that it has done so.

Notes

1. The administration quickly chose to refer to the process as competitive bidding, as opposed to privatization, in order to highlight the fact that competitions were not limited to private firms. City departments were encouraged to bid for contracts as well.

2. Figures throughout this paper are in U.S. dollars.

3. United States Environmental Protection Agency (EPA), Response to Congress on privatization of wastewater facilities (Washington, D.C.: EPA, 1997), p. 5.

3. EPA, pp. 16, 21.

5. Roger Feldman, Tax Code Change Encourages Partnering, 1999. Posted on the Water Industry Council web site: http://waterindustry.org/feldman.htm. Realizing this bias against private investment, the Internal Revenue Service recently decided to allow 10- to 20-year contracts without requiring cities to refinance their outstanding tax-exempt bonds. Water Industry Council, Public-Private Partnering Reshapes Water and Sewer Industry, 1999. Posted on the Water Industry Council web site: http://waterindustry.org/indust-1.htm.

6. Daniel Mullins and C. Kurt Zorn, “Privatization in Indianapolis: A closer look at savings and the wastewater treatment facility,” In Roads, 1 (3), 1996, p. 15.

7. Skip Stitt, telephone conversation with Craig Golding, 13 July 1999.

8. Canadian Council for Public-Private Partnerships (CCPPP), Water Delivery Systems: An International Comparison, unpublished transcript of conference proceedings (Toronto: CCPPP, 1998), p. 18.

9. CCPPP, p. 11. Combined sewer overflows are a problem in cities where storm sewers are combined with the sanitary sewers. During rain storms, sewage networks cannot contain and treatment plants cannot process all of the increased sewer flows; excess is allowed to flow into local waters. Problems of this nature are common in cities where the sewerage infrastructure is very old, as it is in Indianapolis.

10. Mullins and Zorn, p. 10.

11. Jeff Bowden, Glena Carr and Judi Storrer, New directions in municipal services: Competitive contracting and alternative service delivery in North American municipalities (Toronto: ICURR Press, 1997), p. 6.

12. Bowden et al., p. 6.

13. White River Environmental Partnership (WREP), City of Indianapolis contract operations of the AWT facilities and collection system: Fifth year summary of activities (Indianapolis: WREP, 1999), p. 1.

14. Mullins and Zorn, endnote 21, p. 20.

15. Charlene Helton, “Focus on sewer privatization,” Atlanta Journal/Atlanta Constitution, 1 April 1997, p. B03; and Water Industry Council, Partnership saves Indianapolis $24 million. Posted on the Water Industry Council web site: http://waterindustry.org/indianap.htm.

16. Bowden et al., p. 29.

17.United Water, Municipal Info: Indianapolis, IN. Posted on the United Water web site: http://www.unitedwater.com/indnpolis.htm.

18.Water Industry Council.

19. Stephen Goldsmith, The Twenty-first Century City: Resurrecting Urban America (Washington, D.C.: Regnery, 1997), p. 204.

20.Goldsmith, p. 204.

21.Diana Penner, “City sewage plants go private to cut costs,” Indianapolis Star/News, 13 November 1993, p. A1.

22.Lou Ann Baker, telephone conversation with Craig Golding, 16 September 1999.

23.Steven Cohen and William Eimicke,Is Public Entrepreneurship Ethical? A Second Look at Theory and Practice (New York: School of International and Public Affairs, Columbia University, 1998), draft of 18 May 1998. Posted on the School of International and Public Affairs web site: http://www.columbia.edu/cu/sipa/COURSES/PUBMAN/pm4.html.

24.Suez Lyonnaise des Eaux, which had previously held a 30.1 percent stake in United Water Resources, made an offer to buy the remaining shares on August 21, 1999, thereby making UWR a wholly owned subsidiary of SLDE.

25.CCPPP, p. 24.

26.CCPPP, p. 24.

27.Carlton Ray, cray@indygov.org, “Re: AWT Discharge Information,” e-mail to Craig Golding, 10 September 1999.

28.Glenn Pratt, pratt@netdirect.net, “Re: Privatized wastewater treatment plants,” e-mail to Craig Golding, 3 August 1999.

29.Randall G. Holcombe, “Privatization of municipal wastewater treatment,” Public Budgeting and Finance, Fall 1991, p. 29.

30.CCPPP, p. 14.

31.CCPPP, p. 14.

32.CCPPP, p. 27.

33.WREP (1999), p. 1.

34.Helton, p. B03.

35.Amended and restated agreement for the operation and maintenance of the city of Indianapolis, Indiana, advanced wastewater treatment facilities, legal contract, October 1997, p. 31.

36.Amended and restated, p. 32.

37.Amended and restated, pp. 37-38

38.Amended and restated, p. 38.

39.Amended and restated, p. 17.

40.Amended and restated, p. 17.

41.Amended and restated, p. 36.

42.Amended and restated, p. 19.

43.Amended and restated, pp. 19, 22.

44.Amended and restated, p. 23.

45.Amended and restated, p. 18.

46.Mullins and Zorn, endnote 22, pp. 20-21.

47.Amended and restated, pp. 24, 27.

48. Mullins and Zorn, endnote 22, pp. 20-21.

49.Amended and restated, p. 35.

50.Amended and restated, p. 43.

51.White River Environmental Partnership (WREP), City of Indianapolis contract operations of the AWT facilities: Third year summary of activities (Indianapolis: WREP, 1997), p. 4.

52.WREP (1997), p. 5.

53.Amended and restated, p. 35.

54.Amended and restated, p. 8.

55.Skip Stitt, telephone conversation with Craig Golding, 13 July 1999; and Lou Ann Baker, telephone conversation with Craig Golding, 16 September 1999.

56.Pratt, Re: Privatized wastewater treatment plants, 3 August 1999.

57. Amended and restated, p. 15.

58.White River Environmental Partnership (WREP), Indianapolis advanced wastewater facilities White River Environmental Partnership one year summary (Indianapolis: W1I995), pp. 1, 9; and White River Environmental Partnership (WREP), City of Indianapolis contract operations of the AWT facilities: Fourth year summary of activities (Indianapolis: WREP, 1998), p. 1. WREP’s figures for the number of employees before privatization vary from 322 to 328.

59.Helton, p. B03. According to Helton, 197 employees were hired by WREP. The discrepancy is due to one individual who took a position with one of the WREP partners but was not associated with operations in Indianapolis.

60.Amended and restated, p. 33.

61.Amended and restated, p. 33

62.U.S. Conference of Mayors, “City of Indianapolis, IN,” excerpted in Public/Private Partnerships in Municipal Water and Wastewater Systems: Case Studies of Selected Cities. Posted on the U.S. Conference of Mayors web site: http://www.usmayors.org/USCM /urbanwater/documents/indianap.htm.

63.WREP (1999), p. 2.

64.WREP (1999), p. 2.

65.U.S. Conference of Mayors.

66.U.S. Department of Labor, “Snapshot: Indianapolis,” Final Report of the Secretary of Labor’s Task Force on Excellence in State and Local Government Through Labor-Management Cooperation (Washington, D.C.: USDOL, 1996). Posted at the Cornell University School of Industrial and Labor Relations Martin P. Catherwood Library electronic archive: http://www.ilr.cornell.edu/library/e_archive/LaborExcellence/WorkingTogether/chp2snap.htm. Also available at the U.S. Department of Labor web site: http://www.dol.gov/dol/sec/public/media/reports/worktogether/cover.htm

67. WREP (1999), p. 2.

68.WREP (1995), p. 1.

69.United Water.

70.Cohen and Eimicke.

71. David Osborne, “The Service Secret,” excerpt from Banishing Bureaucracy: The Five Strategies for Reinventing Government (Reading, MA: Addison Wesley Longman, 1996). Posted on Feedback, February 1997, U.S. Army Morale and Recreation Newsletter: http://trol.redstone.army.mil/mwr/feedback/feb97/page12a.html.

72.Steve Quick, telephone conversation with Craig Golding, 15 December 1999.

73.Quick.

74.City of Indianapolis, “Goldsmith announces savings from wastewater privatization,” press release, 5 August 1999, p. 3.

75.Ken Barlow, Case study #2: Advanced wastewater treatment plants. Posted on the City of Indianapolis web site: http://www.IndyGov.org/mayor/comp/indyexp/part1/chapter1/wastewat.html.

76.City of Indianapolis 2000 annual budget: Department of Public Works. Posted on the City of Indianapolis web site: http://www.indygov.org/controller/budget2000/dpw_budget.pdf.

77.WREP (1999), p. 3.

78. City of Indianapolis, “Goldsmith announces . . . ,” Attachment C: Awards.

79. City of Indianapolis, “Goldsmith announces . . . ,” Attachment C: Awards; and WREP (1998), p. 2.

80.WREP (1999), p. 3.

81.Water Industry Council.

82.Richard Van Frank, vanfrank@iquest.net, “Re: One further question,” e-mail to Craig Golding, 4 December 1999.

83.Brant Cowser, mrriver@surf-ici.com, “Re: One further question,” e-mail to Craig Golding, 4 December 1999.

84.Glenn Pratt, pratt@netdirect.net, “Re: O3 vs. Chlorine,” e-mail to Craig Golding, 20 December 1999.

85. Kyle Niederpruem, “City strikes deal over fish kill: It took more than 2 years and some political manoeuvring, but White River restocking to begin,”Indianapolis Star/News, 2 February 1997, p. C01. These actions highlight the importance of firms’ environmental records in a competitive environment. The fact that firms that have damaged the environment will be at a competitive disadvantage provides strong incentives to perform responsibly.

86.Niederpruem.

87.WREP (1999), p. 6.

88. U.S. Conference of Mayors.

89.Bowden et al., p. 29.

90.Mullins and Zorn, p. 15.

91.City of Indianapolis 1999 annual budget: Department of Public Works: Contract Compliance Division. Posted on the City of Indianapolis web site: http://w2.indygov.org/controller/budget99/dept4/d4_d430.htm.

92.City of Indianapolis 2000 annual budget.

93.WREP (1999), p. 7. Documents provided by Mr. Larry Maddux of the City of Indianapolis Department of Capital Asset Management verify the magnitude of these savings.

94.Envirobiz, “United water contract extended for Indianapolis partnership; nation’s largest wastewater partnership to save city $189 million.”Envirobiz (1997). Posted on the Envirobiz web site: http://www.envirobiz.com/newsdaily/97110602.htm.

95.United Water.

96.Penner, p. A1.

97.Barlow.

98.Helton, p. B03.

99.U.S. Conference of Mayors.

100.WREP (1999), p. 5.

101.WREP (1999), p. 5.

102.CCPPP, p. 18.

103.WREP (1995), pp. 4-5; and WREP (1999), p. 7. Private sewage haulers remove and dispose of wastes from septic tanks and other rural collection systems.

104.WREP (1995), p. 5.

105.Mullins and Zorn, p. 16.

106.Baker.

107.United Water.

108.CCPPP, p. 18. This includes work done on roads, bridges, sewers, floodways and other municipal infrastructure.

109.Goldsmith, p. 200.

110.City of Indianapolis, “Goldsmith announces . . . ,”Attachment D: WREP Savings Investments 1994-1998

111.City of Indianapolis, “Goldsmith announces . . . ,”Attachment D: WREP Savings Investments 1994-1998.

112.Mullins and Zorn, p. 11.

113.CCPPP, p. 27.

114.Cohen and Eimicke.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s