Module 13: Financing (cost recovery)

13.1. What are the objectives of cost recovery?

A primary objective of the municipality is to provide a sustainable service delivery. Ability to ensure a stream of revenue, coming either from user fees or subsidies, will sustain the service delivery so is of the utmost importance.

When municipalities decide to attract private investment capital in their efforts to improve urban services, an effective cost recovery strategy becomes a cornerstone of the successful PPP.
The common objectives for cost recovery policy include to:

◊ attract private capital into the sector to increase payment collection, capacity and to rehabilitate the system;

◊ enhance cost recovery and promote investment;

◊ promote cost effectiveness and ensure economic sustainability;

◊ expand service coverage into poor, peri-urban and rural areas;

◊ make service affordable for vulnerable groups;

◊ provide incentives to the operator for improved service and quality;

◊ make tariff calculation and regulation simple and easy to understand; and

◊ raise effectiveness and quality of the improved service.

The cost recovery strategy should balance three critical and interrelated aspects of sustainable service delivery: quality of service, investment costs and the tariffs that customers are willing and able to pay [see also Tool 13-1]. Achieving sustainable partnerships between the public sector and the private sector provides a means to assist local governments in financing and operating service infrastructure.

In a public-private partnership the ramifications of not achieving cost recovery goals affect not only the project, but also the partners themselves. The private sector loses both its investment and its credibility. The public sector loses the confidence of the public and still has the burden of providing water services. The NGO sector can lose its standing with the communities it works with, which can affect its ability to continue or initiate other programs in poor communities.

How are cost recovered?

The costs associated with service delivery are often disaggregated into three cost centres:

1. Capital (infrastructure) costs – include building assets used for service and products (goods) production and in some cases costs for buildings and grounds.

2. Operational and maintenance (O&M) costs – the cost of actually operating and maintaining the system in order to produce and distribute services.

3. Connection costs – the cost of connecting an individual household to the system.

Throughout this Tool the word “fee” is used for both infrastructure and connection charges. The word “tariff” is used for O&M charges.
All three cost types can be recovered from two sources: consumer fees (tariffs) and/or subsidies. Tariff levels and subsidies are parts of a broad decision-making process and closely related to livelihood strategies – demand, affordability, willingness to pay and income levels. The primary step for a municipality considering tariff levels and subsidies is to determine what the fundamental objective of the tariff and subsidy is, and how that objective informs, supports or conflicts with the overall objectives for reforming the delivery mechanism through a partnership approach.

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