# **3. Methodology**

In this paper, we sought a methodology for estimating the magnitude of subsidies that could be adapted to data scarce environments while better accounting for differences among service providers, such as population served (to account for economies of scale), coverage of water and sanitation services individually, and their level of operational efficiency in terms of water losses and staffing. Accounting for these considerations, Chile’s model firm approach provides a solid methodology through which costreflective tariffs are calculated for each utility, which can then be used to estimate their magnitude of subsidy.

Superintendencia de Servicios Sanitarios (SISS), the Chilean water regulator, uses an efficient (optimized) bottom-up model<sup>9</sup> that provides valuable information on the greenfield capital investment<sup>10</sup> needed for the provision of WSS services that, for the purposes of the present study, we extrapolate to utilities in other countries. It is important to note that our methodology does not seek to benchmark these utilities against Chilean utilities. Instead, our decision to use the efficient model developed by the Chilean regulator is predicated on its sophisticated and novel framework for estimating costs and measuring performance.

To compute an efficient WSS tariff for each utility with sufficient data for the period 2010–15 in the World Bank’s International Benchmarking Network for Water and Sanitation Utilities (IBNET) database,<sup>11</sup> we develop a methodology that complements utility-specific data with estimates of the long-term incremental costs of efficient model firms, as determined by the Chilean regulator.<sup>12</sup> We then adjust this tariff to account for the relative losses and labor inefficiencies of each utility to obtain a full tariff, which allows a return compatible with a utility’s economic opportunity cost of capital (i.e., to be economically sustainable). The subsidies for each firm can then be computed as the difference between this costreflective full tariff and the effective tariff that a utility collects.<sup>13</sup> In order to obtain countrywide subsidy amounts for those countries with partial representation in the IBNET database, we extrapolate the results of those utilities that are listed in IBNET to the rest of the country based on 2015 WSS coverage rates estimated by the Joint Monitoring Programme<sup>14</sup> and population data from the World Bank. Average per capita subsidy figures were then obtained for each of the World Bank’s four country classifications—high income, upper middle income, lower middle income,

> 9 The Chilean method aims to maximize both allocative efficiency (by setting tariffs equal to marginal costs) as well as productive efficiency (by producing efficient quantities at the lowest cost possible, without passing on additional inefficiencies to the customers through pricing) and also allows each utility to generate enough revenue to cover the costs incurred in providing the service. The customer bases of the various Chilean water and sanitation utilities range widely in size, from a few thousand to even over a million, reflecting the heterogeneity present within the sector globally. The resulting data capture the nuances of various cost structures, improving the accuracy of the Chilean model firms when compared with other countries that have undertaken similar approaches.

10 In this context, greenfield capital investment refers to the capital investment required to construct all facilities necessary to provide a given level of WSS services to a utility’s customer base, independent of any preexisting infrastructure or site-related constraints.

> 11 - The World Bank’s International Benchmarking Network for Water and Sanitation Utilities (IBNET) database (https://www.ib <u>net.org/) is an initiative that supports WSS utilities in compiling a set of core cost and performance indicators that are made</u> publicly available to facilitate performance comparisons towards improved service delivery.

12 Although utilities in many countries treat fecal sludge collected from on-site sanitation options, these costs are excluded from our estimation due to data constraints.

13 See more details about the methodology in appendix B.

> 14 A collaborative effort of the United Nations and World Health Organization, the Joint Monitoring Programme is tracking international progress toward the Sustainable Development Goals.

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