Estimating the cost of improving service quality in water supply: A shadow price approach for England and wales

Abstract

Service quality to customers is an aspect that cannot be ignored in the performance assessment of water companies.Nowadayswater regulators introduceawards or penalties to incentivize companies to improve service qualityto customers when setting prices. In this study, the directional distance function is employed to estimate theshadow prices of variables indicating the lack of service quality to customers in the water industry i.e., writtencomplaints, unplanned interruptions and properties below the reference level. To calculate the shadow price ofeach undesirable output for each water company, it is needed to ascribe a reference price for the desirable outputwhich is the volume of water delivered. An empirical application is carried out for water companies in Englandand Wales. Hence, the shadow price of each undesirable output is expressed both as a percentage of the priceof the desirable output and in pence per cubic meter of water delivered The estimated results indicate that on average,each additional written complaint that needs to be dealt with by the water company includes a servicequality cost of 0.399p/m3. As expected,when looking at the other service quality variableswhich involve networkrepair or replacement, these values are considerably higher. On average, thewater companymust spend an extra0.622p/m3 to prevent one unplanned interruption and 0.702p/m3 to avoid one water pressure below thereference level. The findings of this study are of great importance for regulated companies and regulators as ithas been illustrated that improvements in the service quality in terms of customer service could be challengingand therefore ongoing investments will be required to address these issues.