Tuesday, November 20, 2007

Outsourcing O&M in ULBs

I have argued in previous posts about the absence of sufficient supply side depth and breadth in the infrastructure sector in our country. This naturally gets reflected in the limited number of companies with expertise in Operation and Maintenance (O&M) of urban infrastructure sectors like water supply, sewerage, solid waste management and streetlighting. Each of these services consist of a series of components and functions - electrical and mechanical equipments, pumping and distribution network, treatment and disposal facilities, transport logistics etc.

While there are a number of examples of labor and service contracts for each of these components or functions, and even a few O&M contracts of the electromechanical systems, there are no examples of integrated O&M of the entire system. While this is understandable given the virgin nature of such market, it also means that there is limited understanding of the practical issues related with successfully running an O&M contract in these sectors. There are significant uncertainties arising from the information asymmetry between the ULBs and the private operators. The O&M operator invariably hedges these risks by costing them into the contract. Therefore, apart from the lack of competition arising from the presence of a small number of firms, the absence of successful examples of complete O&M and the inherent uncertainties have also contributed to the high costs of O&M contracts in these sectors. Let me illustrate this with a few examples from Vijayawada.

About two years back, we initiated steps to outsource our entire water supply, underground drainage (or sewerage), streetlighting and solid waste transportation logistics. Though there were some labor and service contracts already in operation in these sectors, it was felt that an integrated O&M contract of all the functions in these sectors would be a better option. The objectives included improving operational efficiency, reducing wastages and pilferages, inducting better management practices and technology, and importantly reducing costs.

These efforts provoked a very vocal resistance, with even the Council of the Vijayawada Municipal Corporation (VMC) passing blanket resolutions banning outsourcing of O&M in any sector. A campaign to educate the opinion makers about the need to outsource such services and its benefits failed to cut much ice. This was understandable given the impersonal and technical nature of the problems and the benefits arising from outsourcing. However it was hoped that the financial savings expected from the contract would convince the opponents of outsourcing.

The major components of the O&M cost are labor and establishment, electricity charges/POL, consumables, and repairs. It is widely believed that a private O&M operators will be able to reduce costs by
1. Better labor management and greater worker productivity
2. Using technology (energy saving devices and better maintenance) to reduce energy consumption
3. More efficeint utilization of consumables and preventing wastage and pilferage
4. Reduce repairs by better maintenance

The National Competitive Bidding process in each of these sectors took 6-9 months to be completed. In the absence of similar examples elsewhere, the bid documents had to be prepared, more or less afresh, and repeated pre-bid meetings organized to clarify the numerous doubts and misgivings. In fact, it took sometime for us to document and prepare an inventory, with all the relevant information, about the assets which were to be outsourced.

The actual cost of O&M for the water supply chain upto the storage reservoirs, incurred by VMC is Rs 1.1 Cr per year(or say, Rs 3.5 Cr for three years), excluding the electricity charges. But the lowest quoted bid was Rs 8.30 Cr for a three year period. While the actual cost of O&M for sewerage was Rs 0.60 Cr, excluding the electricity charges, the lowest bid was for Rs 1.30 Cr. However, in both streetlighting and solid waste transport logistics, the final bids produced substantial savings. As a consequence, it was possible to sell the O&M of both streetlighting and solid waste transport logistics to the Council, while both water and UGD failed to get approved.

On closer analysis, there emerges several reasons for the higher costs quoted by these firms, especially in water and sewerage sectors. Some of the major reasons are listed below.

1. In the labor contracts under operation in most ULBs, labor is sourced at rates much lower than the notified minimum wages. Typically, ULBs identify their labor requirements of various categories and call for tenders, inviting response from labor contractors who can procure and supply the required numbers at the lowest cost. The market, in all but the more skilled categories, is very competitive and hence gets bidded below the minimum wage. For example, while the minimum wage for unskilled labor is Rs 120 per day, the actual wage rate varies from Rs 75-100. The average wage proposed by the O&M operator is Rs 150 per day. The major O&M operators, bound as they are by contractual obligations and mandatory internal requirements, do not have this flexibility and end up paying atleast the minimum wage.
2. Under the standard ULB maintenance arrangement motors, pumps and different equipments get repaired only when they break down. O&M contractors, in contrast, have a preventive or precautionary maintenance schedule for each equipment and device depending upon their age and use. This not only helps in preventing repairs, but also palys a significant part in incresing the operational lives of these devices. These costs get loaded into the O&M rates quoted by these contractors.
3. The ULBs or Government agencies do not employ specialists and do not take their services in the O&M of these systems. O&M contractors utilize the services of various specialists like environmental engineers, chemists, structural engineers etc, whose services are expensive and get added to the O&M cost. The salaries of the skilled regular engineering personnel are also much higher than correpsonding salaries paid by the Government.
4. Standard maintenance schedules like painting and other external servicing is done very infrequently in government run installations. The sewerage O&M contract, for example, includes work components like desilting of all sewer lines, which is never done, unless the lines overflow, when maintained by the ULB. O&M contractors factor these costs into their bids.
5. In the absence of clear information about the age and other operational history of devices and equipments, the O&M contractor is forced to quote higher rates for anticipated repairs. This often gets reflected in higher operational costs too.
6. Different taxes, that are not incurred when the ULB or Government agency does the O&M, increases the cost by over 20%. The service tax is 12.25%, income tax 2.25%, and other taxes on procurement often goes beyond 5%.

Another factor that is responsible for the lack of competition is that such integrated O&M services require cross-sectoral expertise, which only the major contractors have. Such barriers to entry, invariably excludes all the smaller, local operators whose expertise is often limited to a few functions and not the full spectrum of activities involved. The high technical and financial qualification norms and experience prescribed in Government bidding regulations also militates against the smaller contractors.


Anonymous said...

Interesting. Thanks for the article.

You can also find outsourcing to india at ICanFreelance.com.

Anonymous said...

Thank you for posting such a useful, impressive and a wicked article.
We are with you, and wish you all the best in your endeavour to serve mankind.