Optimal Size for Utilities? Returns to Scale in Water: Evidence from Benchmarking

Water and sanitation services involve large shared infrastructure costs, and adding more customers usually means that each one pays a smaller share of these costs. As systems become larger, however, growth in the administrative and coordination costs of running them can start to outweigh gains in the unit costs of service provision—the so-called X-inefficiency. In addition, the costs of expansion to more remote settlements can start to raise unit capital costs when averaged across the entire service area, an important contributor to total costs. Moreover, greater decentralization of water service delivery brings growing political challenges to establishing bigger systems. Earlier econometric research using data from high-income countries concluded that water providers may operate cost-effectively through a range of sizes, with even small utilities facing economies of scale that can be significant.1 This Note provides a first look at the link between a provider’s size and its unit costs using data from low-, middle-, and high-income countries. It shows that utilities, particularly those serving a population of 125,000 or less, could reduce per-customer operating costs by increasing their scale of operation.