WATER GLOBAL PRACTICE WSS GSG UTILITY TURNAROUND SERIES Case Study— Kiskun-Viz, Hungary By András Kis and Maria Salvetti AUGUST 2017 Key Characteristics of Aggregation Case Study KISKUN-VIZ, HUNGARY Context • High-income country • Aggregation covering urban and rural areas • High level of water supply and sanitation (WSS) performance Purpose Economic efficiency, performance, professionalization Scope WSS functions and services Scale • Administrative boundaries • Localities covered: 54 for water and 35 for wastewater • Population covered: 161,000 inhabitants for water and 141,000 for wastewater • Coverage: 100% for water; 87% for wastewater • Connections: 63,670 for water and 43,658 for wastewater • Network length: 1,377 km for water and 906 km for wastewater Process Top-down Governance • Merger • Public company • Decision making: municipalities and the Hungarian state are the utility’s shareholders • Asset transfer: assets remain the property of municipalities and are managed by the operator as part of the merger agreement • Liability: liabilities and debts from previous operators are taken on by aggregated utility • Staff transfer: all staff was transferred • Clear entry and exit rules Outcome Positive, with decreased operating expenses Findings Political resistance when choosing utility headquarters location and nominating CEOs; difficulty retaining skilled staff because of financial constraints; accountability mechanisms toward employees; harmonization of operating practices among aggregated entities on the basis of best practice; accountability toward customers (satisfaction survey); aggregation appears beneficial, especially for service quality and sustainability in small municipalities 1 In 2011, when the Hungarian parliament voted on the water and sanitation services. Act XXXIII of 1991 stipu- Act on Water Utility Services, the three water utilities lated that the assets of state-owned companies were to of Halasvíz, Kalocsavíz, and Kőrösvíz—which had pre- be transferred to local governments. The former compa- viously worked together—quickly decided to merge. nies that had been operating on a county level split into This corporate merger is the only example of its kind in several smaller water utility companies, driven by the Hungary following the mandatory aggregation reform. municipalities’ desire to achieve independence in local Although the merger negotiations and the design of service provision to match their obligations of supplying the aggregation were quick and smooth, implementa- services. Some municipalities contracted with private tion of the aggregation triggered challenges among the operators through management contracts or conces- merging partners. Those challenges were overcome, sions, but most settlements continued to be supplied by and the aggregation delivered benefits to all partners, municipally owned water utility companies. In 1989, with reduced operating costs and with a limited there were 38 water utilities, and by 2010 there were increase in performance. more than 400, predominantly owned by local govern- ments. However, in 2012, the 33 largest companies were From Fragmentation to Aggregation of providing drinking water for 85 percent of the Hungarian Hungary’s WSS Utilities population. Nevertheless, the large number of water util- ities meant that there were huge differences in service After World War II, during the Communist era, Hungary’s levels, prices, cost recovery, and operating efficiency, as water sector was highly fragmented. There were more well as in sustainability. Recognizing that situation, the than 400 water utilities, most of which were owned by Hungarian Parliament adopted Act CCIX of 2011 on Water local councils. The aim in the 1950s was to halt and Utility Services. That act reflected a new vision for the reverse fragmentation by connecting the neighboring sector, including national regulation through a regula- water utility systems in the country. A number of state- tory agency, uniform tariff-setting procedures, and owned water utilities were then created, and small water achievement of major aggregation within the sector. As a utilities were merged. That process resulted in the inte- result, a wave of aggregation swept the country, trig- gration of water services into 34 water utilities. Those gered by a regulatory requirement on the minimum size companies were operating predominantly at the county required to obtain an operating license. From January 1, level and in larger towns. After the 1989 change of 2017 onward, water utility companies have to serve at regime, Act LXV of 1990 on Local Governments declared least 150,000 consumer equivalents (CE) to be allowed to that local governments were responsible for providing operate. The number of utilities FIGURE 1. Water Utilities in Hungary fell from more than 400 in 2010 to 41 by 2017 (figure 1). 450 400 A Merger between Three 350 Utilities that Were Used Number of utilities 300 to Working Together 250 Before 1993, the Dél-Bács-Kiskun 200 Megyei Vízmű Vállalat utility 150 (South Bács-Kiskun County Water 100 Utility Company) supplied ser- 50 0 vices in southern Bács-Kiskun 1950 1962 1989 2010 2012 2013 2014 2016 County. But after a water 2 Case Study—Kiskun-Viz, Hungary sector  reform, the utility was disaggregated into four decided to reach the regulatory size threshold on its medium-size utilities (each serving between 10 and own, and it quit the negotiations. The other three utili- 20  municipalities) and several small utilities (each ties continued to discuss the merger (see map 1). That serving only 1 or 2 municipalities), all owned by the ­ preparatory phase lasted through 2012, and in September municipalities they serve. Even though the disaggre- 2013 the three utilities signed a merger agreement that gated utilities started operating individually and inde- stipulated clear entry and exit rules. The capital of the pendently from one another, the four medium-size aggregated utility is owned by the Hungarian state (8.35 companies (Halasvíz, Kalocsavíz, Bajavíz, and Kőrösvíz) percent) and the municipalities served by the utility. The continued to cooperate either formally or informally. name of the aggregated utility was changed to Kiskun- Those companies were used to borrowing equipment Víz, and by 2013 the utility had already reached its final from one another, sharing information, and organizing aggregated size, four years ahead of the legal deadline. events together. Hence, when the Act on Water Utility This merger has been managed by the top management Services was passed in 2011, it appeared natural to the of the three companies because no external consultant four utilities’ directors to start merger discussions. They was hired to help with the process and no dedicated received approval and support from their municipal merger team was set up. Kiskun-Víz took over all con- councils to do so. After a short while, the Bajavíz utility tractual obligations of the three former companies. MAP 1. Kiskun-Víz Kft. Drinking Water Supply in January 2017 Case Study—Kiskun-Viz, Hungary 3 Those liabilities usually did not extend beyond 1.5 to 2 A specific IT-related challenge arose after merger— years post-merger. When those supplying contracts namely, the integration of the three companies’ IT were not advantageous, Kiskun-Víz did not renew them services. The aggregated utility of Kiskun-Víz selected ­ upon expiration. At the time of the merger, all 320 the IT customer databases and invoicing systems from employees from the merging companies were offered Halasvíz to be used going forward, and data were continued employment at their current salary. The ini- migrated from the other aggregating companies. This tial discrepancy between job descriptions and associ- migration created a one-off cost for the years 2012 and ated wages was gradually addressed. By 2017, uniform 2013. Customer service operations were suspended for job descriptions had been created and the salary gap had one day because of the transition. Kiskun-Víz issued its been closed by raising lower salaries to the level of the first post-merger invoice in November 2013. The con- highest ones for similar jobs. This adjustment repre- solidated system for managing outstanding invoices sented an average salary increase of 8.5 percent over was ready in 2015. A central customer service office three and a half years. Transitioning was also facilitated was supplemented by two new local offices open three by the fact that about  one-third of the 320 employees days a week and by a number of small “customer ser- had previously worked  together at Dél-Bács-Kiskun vice points” that are available once a week in some of Megyei Vízmű Vállalat until 1993. Familiarity among the smallest settlements. The three merging compa- employees led to increased cooperation and teamwork nies (Halasvíz, Kalocsavíz, and Kőrösvíz) also brought in the new, larger company. different operating practices into the merged company. In each instance, Kiskun-Víz selected the best practice and implemented it companywide. For example, Challenges between Merging Partners Kalocsavíz had an efficient system for the manage- during the Implementation Phase ment of unpaid invoices, which was adopted through- Although the merger negotiations and the design of out the aggregated utility. The frequency of meter the aggregation were quick and smooth, implementing reading was also reduced, and electronic payments the aggregation triggered challenges regarding (a) har- have been implemented for all customers, while cash monization of administrative practices and IT systems payments are no longer accepted. and (b) the selection of the headquarters location. Another challenge concerned the location of the new To ensure balanced representation of the municipali- company’s headquarters. Each of the merging compa- ties previously supplied by the three merging compa- nies feared that it would have less control over com- nies, each of the merging companies appointed a pany operations if the headquarters was located in managing director to be responsible for the service another company’s territory. Therefore, Kiskun-Víz area that its company used to cover. As a result, Kiskun- decided to set up the new headquarters in Kecel, a Víz had four managing directors: a general chief execu- minor town in the geometric center of the merged ser- tive officer and three regional managing directors. This vice areas. This seemingly neutral location turned out structure did not work very well, and in January 2015, to be an unsatisfactory compromise: the headquarters about 16 months after the merger, the management building itself was unsuitable and too small, and a structure was reorganized. At present, Kiskun-Víz has large share of the administrative staff had to endure a three directors: a chief executive officer, a technical long daily commute. During 2014, all the merging director, and a finance director. (It should be noted partners realized that the new company was working ­ that one director comes from each of the areas repre- well, and mutual trust was strengthened. As a result, sented by the three former companies.) in  January 2015 the headquarters was moved to 4 Case Study—Kiskun-Viz, Hungary Kiskunhalas, which is the biggest town within the ser- most notably the travel costs of specialized person- vice area and is the original headquarters of one of the nel serving a larger operating area and the cost of merged companies (Halasvíz). Many employees have a employees’ daily commute to the headquarters, shorter commute, and the utility sponsors a free mini- which is subsidized by the utility. In addition, some bus service for commuters. new cost items appeared because of legal obligations set by the 2011 water utility regulation. Those costs, Increased Economic Efficiency and Slightly which encompass items such as energy audit and Improved Performance invoicing audit, are not directly linked to the aggre- gation process. Economic efficiency has been improved through the merger for both water and wastewater services. Sewer blockages slightly increased after aggrega- Operating costs of both the drinking water service tion, possibly because of limited resources avail- and the wastewater service decreased after aggrega- able for reconstruction and regular maintenance. tion (see figure 2). The management of Kiskun-Víz Staff productivity per connection first increased stated that procurement costs for inputs such as and then declined, probably as a result of the energy, fuel, chemicals, and work clothes declined increasing number of wastewater connections in slightly as a result of volume purchasing. The unit 2016. (See figure 3.) On more qualitative grounds, a cost of central administration, including company customer satisfaction survey is now in use in management and customer service, also declined Kiskun-Víz, whereas this was not the case in the following the consolidation of those tasks within the three companies before the merger. The quality of merged company. However, some costs increased, drinking water has clearly improved, as has FIGURE 2. Economic Efficiency of Kiskun-Víz Utility a. Opex per cubic meter b. Opex per water and wastewater connection 300 30 Aggregation Aggregation 250 25 200 Hungarian forint Hungarian forint 20 150 15 100 10 50 5 0 0 2010 2011 2012 2014 2015 2016 2010 2011 2012 2014 2015 2016 Opex/m (water produced) 3 Opex/connection (water) Opex/m3 (water sold) Opex/connection (wastewater) Opex/m (wastewater collected) 3 Note: Opex = operating expenses. Case Study—Kiskun-Viz, Hungary 5 FIGURE 3. Efficiency of Kiskun-Víz Utility the Water Utility Services act, passed in 2011, states that water licenses shall be issued to providers reach- Kiskun-Víz Utility ing a certain level of aggregation, expressed in con- 3.5 sumer equivalent. But no administrative limits such as Aggregation watershed or regional boundaries were set. The utility 3.0 of Kiskun-Víz opted for a quick implementation of 2.5 aggregation and reached its final aggregated size by 2013, four years ahead of the legal deadline. 2.0 1.5 Lesson 2: Harmonization of Administrative Practices has Increased Performance Without Generating Cost 1.0 Increase 0.5 When the scope of aggregation includes consolidation of functions, a harmonization of administrative prac- 0 tices across aggregating service providers is necessary. 2010 2011 2012 2014 2015 2016 In the best-case scenario, this harmonization leads to Sewer blockages nb/km/year elevating standards to those of best practices. In Sta productivity sta /W + WW connections Hungary, the three merging companies—Halasvíz, Note: nb = number, W = water, WW = wastewater. Kalocsavíz, and Kőrösvíz—brought different operating practices into the merged company, Kiskun-Víz. Those effluent treatment; however, those achievements practices were harmonized by selecting the best prac- cannot be totally attributed to the merger because tice in each case and implementing it companywide. they are the result of a European Union–funded For example, Kalocsavíz had an efficient system for the program that started before 2013. management of unpaid invoices, and that system was Overall, Kiskun-Víz succeeded in managing transac- adopted throughout the aggregated utility. As a result, tion costs (related to staff transfer, IT systems integra- the overall level of unpaid bills was halved. tion, and harmonization of administrative practices), Lesson 3: Transaction Costs can Hamper Aggregation which did not increase costs in the long run. In Success addition, service performance improved, especially in ­ Transaction costs occurring before, during, and after rural areas where quality standards are now as good as aggregation can hamper aggregation success or limit those in urban areas. and delay the benefits of aggregation. Transaction costs can take many forms. Aggregation Case Study at a Glance Key Lessons Learned from the Aggregation Labor costs Case Study In Hungary, following aggregation, human resources Lesson 1: Defining Principles but Allowing Flexibility in policies have focused on training programs and wage Implementation Ensures Local Ownership increases to attract and retain skilled staff. At Kiskun- National reforms are more likely to be successful when Víz, the salary gap among the staffs of the three merged they follow the principle of subsidiarity and allow flex- companies was gradually closed by raising lower sala- ibility for local stakeholders to own the aggregation ries to the highest level of those for similar jobs, with process and adapt it to their local context. In Hungary, an average increase of salaries r ­ epresenting 8.5 percent 6 Case Study—Kiskun-Viz, Hungary over three and a half years. Other labor-related costs customer databases and invoicing systems from also increased, most notably the travel costs of special- Halasvíz, one of the three companies that merged, to ized personnel serving a larger service area and the be used companywide, and data were migrated from cost of employees’ daily commute to the headquarters, the other aggregating companies. This migration cre- which is subsidized by the utility. ated a one-off cost for the years 2012 and 2013. Customer service operations were suspended for only IT systems one day because of the transition. Kiskun-Víz issued its Transaction costs related to the merger of IT systems first post-merger invoice in November 2013. The con- between aggregating entities occur during aggregation solidated system for managing outstanding invoices implementation. In Hungary, Kiskun-Víz selected the was ready in 2015. Case Study—Kiskun-Viz, Hungary 7 © 2017 International Bank for Reconstruction and Development / The World Bank. Some rights reserved. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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