Successful and long-lasting businesses are all about capturing and creating value. Value creation or value added can broadly be defined as taking an action where the benefits of the action exceed the costs of the action. For example, value creation can manifest itself through increased quantity and improved quality. Value capture has to do with retaining a portion of value in a transaction with the consumer and is typically achieved through pricing. When looking at environmental products or services, the role of creating and/or capturing value may not be readily apparent.
Take a water utility for example. How could an existing water utility actually create value? Water quality is regulated at the federal level and in most cases at the state level as well. Going above and beyond the water quality requirements may not result in a water resource that a typical customer demands or needs. Moreover, it is unlikely that customers would be willing to pay a price above the cost of implementing that improved quality. That’s not to say that water utilities are unable to create value, but rather these value creation opportunities are more difficult to identify and are most likely tied to local or regional characteristics. Generally water utilities have more opportunities to capture value rather than create it.
Pricing determines what value is captured by the utility and any additional value is retained by the customer, which can be thought of as the difference between what the consumer would have been willing to pay for the water and the price that the utility actually charges. In theory, because water is an essential resource, customers would pay whatever price was set by the utility for whatever amount of water they needed to survive. However, other social and political issues including affordability come into play that prevent water utilities from setting excessively high rates. In fact, many water utilities struggle to set rates that capture enough revenue to even cover their costs.
The Environmental Finance Center at UNC has been working hard to develop ways to help water utilities effectively capture value and improve their financial stability. Working with the Water Research Foundation, the Environmental Finance Center developed a “Water Utility Revenue Risk Assessment Tool” that can be used by utilities to show how prone they are to revenue variability based on their rate structure, residential customer demand patterns, and weather variability. The tool allows water utilities to see how exposed their revenues are to loss if there is a sudden and significant decline in water demand. Using this revenue exposure information, utilities can work to minimize risk while still effectively and efficiently capturing value. Together with Ceres, we used the tool with three utilities and identified several important lessons for utilities on revenue resiliency that are published in our report “Measuring & Mitigating Water Revenue Variability: Understanding How Pricing Can Advance Conservation Without Undermining Utilities’ Revenue Goals“.
In another project, the Environmental Finance Center is working with the state of Missouri on setting Clean Water Fees that help fund their Clean Water Act programs. By looking at the state’s fee levels and structure and comparing it to peer states, the Environmental Finance Center developed a spreadsheet model unique to Missouri that can be used to show the financial impacts of different fee scenarios. The model can be used to show the effects of changes to the fee levels and the fee bases. By comparing these different scenarios, the state of Missouri can determine which options are the best fit in terms of capturing value, which allows the program to minimize its reliance on loans and grants, while still satisfying political, public, and business concerns.
Historically the difficulty in valuing natural resources, including water resources, has led to an attitude that these resources are free, which is simply not the case. Water resources and natural resources in general, do in fact have a monetary value and there have been significant advancements in the metrics used to calculate the value of these resources. Entities like water utilities are primarily concerned with charging customers the cost of delivering clean water. In the future however, water utilities may consider capturing some of the value of their actual water resource. Moving forward, it is important to keep in mind that valuing the environment is hard, but not impossible, and utilities that begin to understand the underlying value of their resources will be poised for continued, long-lasting, and financially stable success.
Katie Bradshaw is a Research Assistant at the Environmental Finance Center at UNC Chapel Hill. She is a joint-degree student pursuing her MBA from UNC Kenan-Flagler Business School and Master of Environmental Management degree from the Nicholas School of the Environment at Duke University.
One Response to “The Business of Water: Capturing and Creating Value”
I’m so grateful you shared this! I plan to check out the article you mentioned.