The importance of capital efficiency.
Published on: 23/01/2019
In our daily lives we are bombarded by offers to get more for less. And we respond accordingly as we strive to balance our household budgets. This saves us a few dollars here and there, perhaps hundreds of dollars on a big-ticket item, and we get to feel good about ourselves and our financial skills.
But when it comes to the millions of dollars invested in infrastructure around the world, do we have the same attitude towards buying more for less? This is a question that is difficult to answer.
As practitioners we often focus our attention on operational efficiency. What were this year’s costs compared to last year’s? Is efficiency increasing or decreasing? There are suites of tools to give technical comfort to back up such assessments – from simple ratio analyses through to more sophisticated approaches such as econometric modeling and Data Envelope Analysis.
But what about capital efficiency? The assessment is not so simple as, in most cases, this is a prospective assessment – that is to say, a comparison of what was spent compared to a hypothetical of what might have been spent. It is rare to have a side by side comparison. Yet in the water sector, annualized capital costs can be equal to the annual operating costs. So, when we focus on operational efficiency, we are in fact only looking at half the story.
At the same time, we talk about mobilizing more finance to fill the gap between historic investment levels and projected investment needs. Yes, there will always be a financing gap in all countries around the world. However, whilst thinking about bridging that financing gap (“Maximizing Finance for Development” comes to mind), shouldn’t we also be thinking about how to reduce the financing gap by being more efficient in our use of capital?
In this recently published report, part-funded by the Global Water Security & Sanitation Partnership (GWSP), we highlight international examples from the water and sanitation sector where results have been delivered for less money – capital efficiency. By focusing on capital efficiency, we can reduce the sector’s future financing gap, and thus make filling that gap somewhat easier. The report looks at eight broad categories where potential capital efficiency gains can be made:
The report highlights many technical alternatives that can deliver more for less. Most show savings in excess of 25% compared to traditional solutions. Or, put the other way around, we could get 30% more benefit from the same investment.
Unfortunately, one of the challenges in delivering greater capital efficiency comes from the way many donor funds are passed to end users. If funding is provided at zero cost to the end user (e.g. a utility) then they are agnostic as to whether it costs $50m or $70m to provide a new facility. If they were contributing to debt service costs, it is very likely they would pay closer attention!
In a capital scarce world, don’t we need to challenge ourselves to focus more on better use of the capital allocations that we receive? And we need tools to help us do that.
Surprisingly, whilst investing in infrastructure is our core business, it is hard to find information on capital costs. In the Water GP we have a massive database on operating costs and performance data from hundreds of utilities around the world, yet a counterpart for capital costs has yet to be developed. It may be the same in other sectors.
As practitioners, therefore, we should perhaps start to think more carefully about how we encourage capital efficiency. Yes, let’s mobilize more financing into the sector – but let’s also make sure that the investments made are the minimum to achieve the required outputs.
So next time you get excited by all those “special offers” on display in shops and online stores – please spare a thought for how we can develop our own “special offers”. For sure no-one would complain if they can get three for the price of two!
This post by Bill Kingdom was originally published on the World Bank's Water Blog on 7 January 2019.
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