The Dynamics of Garbage Collection: A Case Study of Privatisation.

Abstract

This paper outlines a consulting assignment with a local government authority in New Zealand where there has been significant privatisation of local government services. The literature indicates that the jury is still out on the benefits of privatisation and this paper examines some specific dynamics of the process. Participants in a Systems Thinking seminar identified the privatisation of a publicly funded service as an appropriate problem for analysis. They constructed a causal loop diagram of the situation. This diagram was later refined by the consultant and an iThink model constructed. From this it was possible to examine the reasons for the failure of the Council to reach a number of its policy objectives. A subsequent analysis of other possible scenarios suggests that the policy of privatisation was seriously flawed. The paper suggests that the dynamics of the competitive environment may ultimately determine the success or failure of efforts to privatisation. It is further suggested that the mental models arising from participation in a regulated or monopoly market need significant revision if privatisation of local government services is to succeed.

Context

One of the fundamental tenets of the rationale for privatisation is that competition improves efficiency. In the situation where a monopoly is privatised, it will need to compete for capital and provide a competitive return for investors. This pressure will improve efficiency over that of the private sector. If a public sector activity is exposed to the pressure of competition through allowing private firms to bid for it, then competition will lead to costs savings. 

This view was emphasised by the Australian Foreign Minister, Mr Bill Hayden in the 1985 Chifley Memorial Lecture, who stated that,

“The resources it (public enterprise) uses belong to the people.  The money it uses comes from the taxpayer.  There is no practical or moral validity in maintaining public enterprise which wastes or risks these resources in doing less well what the private sector is doing.” 

                                                           (Chin & Webb, 1987:39)

The Business Council of Australia (BCA) suggests that given private enterprises are typically more efficient than public enterprises, the debate should instead focus on whether goods and services should be provided by the private sector, and how this best serves the interests of Australians (Chin & Webb, 1987:26).

The Australian Chamber of Commerce (ACC) has “long opposed inefficient government involvement in essentially private sector activities and excessive regulation of private sector activities.” This type of bureaucracy stifles small business and entrepreneurial initiative, which is itself essential to long term economical growth and employment opportunities (Chin & Webb, 1987:26).

Abelson (1987:311) states that the theory and evidence available supports the premise that many goods and services in a competitive environment could be produced more efficiently by the private sector. That is, at a lower price to consumers and a lower cost to firms.

The Evatt Research Centre (1990:5) states that proponents of privatisation make a number of points.  They argue that public assets must be sold off, or services contracted out, in order to compensate for high taxation and government expenditure. Advocates of privatisation believe that public organizations lack a concise profit objective and market discipline, and are thus less efficient than private enterprises.  This point has evoked much publicity, however the evidence suggests that neither perspective has been victorious.

Wiltshire (1989:31), reviews the arguments put forth by Australian proponents of privatisation include; the provision of capital for Government business enterprises which enable funding of expanding industries such as telecommunications, finance, the elimination of political interference by revealing widespread Government compromising via cross subsidisation, imposed community service obligations. The reasons underlying criticisms of privatisation include; community service obligations/ cross subsidisation will be negatively affected as will the equity and access to basic services, particularly for disadvantaged and/or minority groups and that efficiency can be achieved within the public sector providing enterprises are financing their capital needs from their earnings.

According to the 1989 Auditor General of Canada, Mr Kenneth Dye, the Government gave a number of reasons for pursuing the privatisation path (Dye, 1989:231). Up to this time there had been two principle kinds of privatisation undertaken by the Canadian Government.  Firstly, contracting out certain operational activities, such as the Canada Post Corporation contracting out full postal services to the private sector or the Department of Energy, Mines and Resources contracting out the surveys, mapping and remote sensing activities to the private sector. Secondly, privatisation has involved the divestiture of Crown corporations through the sale of shares or assets.  These included Canada Development Corporation (holding company), Canadian Arsenals Limited (munitions manufacturer), Canadair (aircraft maker), and Teleglobe Canada (telecommunications company).

According to the Government, the reasons for privatisation in Canada are that due to a changing economic environment, the initial objectives for establishing many Crown entities are no longer applicable. Thus other means are sought to fulfil public policy objectives. The issue of effectiveness is also under debate with the Government having claimed that the private sector is more efficient in serving the needs of the consumer.  It is further argued that the Crown corporations monopolise a great deal of public money and furthermore place unnecessary demands on the Government. The Government claims that the corporations rely on the public purse and are thus risk adverse and slow to respond. Finally, the Government of Canada stated that it is not fair for the private sector to have to compete against their own taxes, as a result of competing with Crown corporations (Dye, 1989:234).

Theoretical analysis and empirical evidence support the view that private ownership is most efficient, and hence suitable, in markets where effective (actual or potential) competition prevails (Vickers & Yarrow, 1988:426).  An economic analysis of privatisation in Britain reveals the following companies are an example of this; Amersham, British Aerospace, British Petroleum, Associated British Ports, Cable and Wireless, Enterprise Oil, Rolls-Royce and Jaguar, all of which operate in competitive conditions. In these cases the discipline of market forces serves to channel private energies toward socially desirable ends.  

In contrast privatisation programs for firms with monopoly power appear to have serious flaws, for example, BritishTelecom and British Gas (Vickers & Yarrow, 1988:427).   A 1989 Industry Commission ‘Report on Non-Government Charges’ suggests that the absence of competition in public enterprises is “the single most important factor underlying inefficiency (Clark, 1990:26).

According to Vickers and Yarrow (1988:268), public utility company British Gas has experienced problems in at least four major areas since being transferred to the private sector in 1986.  After the sale of British Gas Corporation, as it was named, the Government did not retain a sizeable shareholding in the company, but instead a new regulatory body was established.  It was known as the Office of Gas Supply (Ofgas).  One of the failures of this privatisation move was that Ofgas was granted limited regulatory powers and thus considerable uncertainty regarding long-term policy resulted.  There was no attempt to restructure British Gas Corporation (BGC) prior to privatisation, therefore senior management of BGC were made senior management of British Gas.  It was management who had the most to lose from restructuring, and as follows were the major beneficiary’s.  

The other two areas of policy failure were that the pricing formula for tariff customers reflected the philosophy of BGC, rather than the new British Gas, and also there was minimal effort made to promote liberalisation by encouraging competition to the dominant supplier (Vickers & Yarrow, 1988:268).  

British Telecom, according to Vickers and Yarrow (1988:235), also experienced tension between the short term and longer-term objectives of the firm.  The promotion of effective competition and regulation was for the most part placed on the back burner, in favour of serving the needs of the pressure groups and promoting the wellbeing of British Telecom.  This view was reinforced by Hewitt (1996) in a brief article on privatisation where he makes mention of the mistakes made by British Telecom. However the author of another article published in The Bulletin states that after the privatisation of British Telecom in 1984, the company transformed itself into a “dynamic, savvy competitor that has diversified at home and expanded overseas” (Frankel, 1994:71). Frankel (1994) reports that in May 1996, British Telecom had annual profits of 2.7 billion pounds, and that shares initially sold in 1984 at 130 pence, in October 1994 sold for 368 pence. The identical situation can be construed (or misconstrued) in opposing ways, however the argument against privatisation in this case appears far more convincing.

Domberger claims that privatisation need not be a poor economic bargain but instead should be considered on a case-by-case basis (Domberger, 1995). Quiggin concludes that a publicly owned enterprise is always more efficient because the government has unlimited access to cheaper funds. Domberger however concludes instead that common ownership of the means of production is the most efficient.  The final point emphasised by Domberger (1995) is that Australia should be looking in the long term at whether a privately owned enterprise performs better than a publicly owned enterprise.

Palmer (cited in Santamaria, 1995a: 26), states that privatisation “has been promoted as a way of saving money and improving services, but private monopolies are often at least as inefficient as public ones, and generally more corrupt.”  At British Gas, president Cedric Brown, had a 75% salary increase, while at the same time 2600 workers had a 16% salary decrease, with a reported 33,000 British workers to be sacked from public service jobs within the next year (Santamaria, 1995a).  Thus it appears that much of the literature on Britains privatisation experience is negative, particularly the experience of British Gas.

Another article by Santamaria (1995b), states that as a result of electricity privatisation in Britain, both the water and electricity industries are to let go 20,000 to 30,000 employees in the next couple of years, not to mention the 20,000 employees already made redundant because of the privatisation move.  As suggested by Santamaria (1995b), privatisation has many thorns that are effectively disguised by those who push for more and more domination of the private sector.

Another of the criticisms of privatisation is that individuals within the private sector are able to freely pursue their own personal interests, without any intervention or constraints placed by the market in regard to minimising costs and maximising profits.  It is also claimed that “public enterprises have access to the public purse and thus do not impose on themselves financial discipline. Consequently, resources are not used in their most productive way and do not satisfy areas of consumer demand” (Cranston, 1987:284).

Piggott (1987:116) argues that there is a number of services provided by the public sector which if privatised would have serious consequences for economic welfare.  To illustrate this point, he refers to anecdotal evidence that ‘for-profit’ nursing homes in the US provide four times the quantity of sedatives per patient compared with ‘non-profit’ nursing homes.  The point being that ‘for-profit’ homes are able to reduce the labour cost of patient care, and if ‘non-profit’ homes were abolished then nursing homes providing labour intensive care would be non-existent. Privatisation of a commodity such as this is likely to have a harmful social impact.

In January 1997, Metro Manila sold off 50% of its water and sewerage system to Ayala Corporation, amidst claims that Ayala would not be able to sustain its quoted prices (Tiglao, 1997).  According to CEO of Ayala, Jaime Augusto Zobel, the projections made by the company “indicate a very strong demand for water over the next several years…this strong demand factor was incorporated in our bid price” (Tiglao, 1997:52).  However a rival firm described the bid as far too low and others have predicted that Ayala will lose over $1 billion in the next ten years.  Ayala will charge 2.31 pesos per cubic metre of water compared to the 8.78 pesos currently charged by the publicly owned Metropolitan Waterworks and Sewerage System.  According to Sun Hung Kai Securities in Manila, the network “could be cash cow” under private management (Tiglao, 1997:52), however it remains to be seen over the next few years whether Ayala really can provide a more efficient and alarmingly cheaper service at a considerably lower cost.

In regard to the belief that the private sector is more efficient, Kernot (1996) says that research has shown that “efficiency and consumer responsiveness is not inherently dependent on ownership, but rather on a combination of good management, effective competition, technological progress, regulation and consumer pressure” (p.5).  

A Monash University case study on 200,000 enterprises and agencies has concluded that there are no efficiency benefits from contracting out previously public sector responsibilities (Kernot, 1996).  In fact, other possible pitfalls of privatisation are that there is no guarantee that consumers will benefit with lower prices instead of shareholders benefiting with higher returns, a private Board of Directors will not necessarily act in national interest as opposed to company interest, and finally, “we run the high risk of ultimately losing our ability to set, maintain and deliver community service obligations in the national interest” (Kernot, 1996:7).

Lyneis suggests that the goals in the privatisation of public utilities are, inter alia, reducingcosts and prices to consumers, ensuring universal service in a manner fair to all competitors, achieving a high quality of service, increasing consumer choice and ensuring strong domestic players. The challenge in this process is that many of the goals that governments are trying to achieve are in conflict that there is a large gap to be closed in terms of the desired state to be reached, particularly in the case of the elimination of cross subsidies and that regulators, who set the conditions under which competition will take place often have difficulty estimating the impact of their actions on competitors in the market.

In summary, it appears that privatisation is not the panacea of the perceived ills of the public sector. This is not to state that public sector delivery is necessarily the best mode of delivery of services. What is suggested is that the dynamics of each situation will dictate the success of privatisation. Furthermore, in contrast to a publicly owned venture whose terms of operation can be legislated for, a privately owned and operated venture is subject to the dynamics of the market place and it is these dynamics that represent a fundamental shift in the modus operandi for privatised public sector services. It was in this context that the examination of the NZ experience was conducted.

The New Zealand Case Study

This case study examines the process by which group-modelling techniques were used to examine the dynamics of the privatisation of a publicly funded service, a garbage collection. This service was run by a Local Council. Local Council government is the second of two tiers of government and is conducted by popularly elected local councils. Government, both National and local in NZ has been driven by strongly rational economic policies and the pressure to increase efficiency through competition and privatisation has been strong.

The political imperative behind privatisation in this council had been a reduction in rates (local taxes) and increased cost effectiveness through competition and user pays. The elected mayor had been clearly identified with his process which, it had been promised would deliver lowered costs through user pays in the garbage service and a reduction in local rates (taxes). The attempt at privatisation of the garbage collection had been a significant failure as it had not delivered the desired outcomes rather the complete opposite: the council was now being forced to support a service that was visibly unprofitable and had not been able to deliver any reduction in rates. It was generally agreed in the seminar that there was little understanding of the reasons for the failure that ran contrary to accepted political and economic wisdom. Needless to say, there was a certain bemused pleasure amongst the bureaucrats at the failure of a scheme that was a precursor to wide spread restructuring of jobs such as theirs in local councils.

The analysis was conducted in a Systems Thinking seminar with senior executives from a division of a large local council in New Zealand. In the course of the seminar participants used causal loop diagrams (CLDs) to deepen understanding of the process of privatisation in a neighbouring local city council. The story that the group told for the CLD was informative. The Council started with three fundamental policy positions. First, that garbage collection would be on a “user pays” basis. Those creating the most garbage would pay per unit rather than having the service financed out of the general revenue from local rates. In addition, it was decided to begin charging a relatively low fee for garbage collection ease the transition from what had traditionally been a “free” service to a user pays service. 

The second policy element was the decision to provide a “free” (cross-subsidised) recyclable collection. This was designed to move residents towards recycling more of their garbage. Over time, the increasing price of garbage collection would increase the amount of recycling. These policies were the starting point for the policy model.

Figure 1: Fundamental Assumptions

The expected reference mode behaviour was:

 
Figure 1: Fundamental Assumptions

The third element of the policy model was to allow a private competition to enter the market. Such competition was allowed to compete with the council service by approaching local residents and offering a service. Those residents using the competitor put red stickers on their bins. Thus both collectors were able to distinguish their own customers. The mental model behind this was that competition would act as a re-inforcing loop that would drive prices down.

Figure 3: The mental model of competition

However, there are now two expected reference modes for Council prices. The first is that defined by what was described as the “social policy” model. This model saw Council as having a responsibility to bring about social change to protect the environment through cross-subsidised recycling. The second was the “competitive” model that aimed at increased efficiencies and benefit to the ratepayers through competition.

 
The social policy model
  
The competitive model
Figure 4: Two opposing policy imperatives

Clearly there is some contradiction here. This may have been explained in the inherently opposing political and ideological views within the Council itself. As the CLD was developed it became clear that this contradiction and the expected behaviour of the Council and the competitor in terms of pricing policy was central to the understanding of the problem. This leads to the next development of the CLD.

Figure 5: The Collection Re-cycling Dynamic

It was decided that it was most likely that Council would continue with its social policy on recycling and that as Council prices increased the competition would be likely to follow them upwards as there was little incentive to hold prices down. So much for competition. Increases in the prices of both players would drive their respective collections down. This in turn would drive the total garbage collected down and the recycling up. It was also assumed that any customers that the competitor gained would be at the Council’s expense as the Council currently had a monopoly. 

It was at this point that a central question was raised: What was the expected behaviour of the competition in terms of pricing policy. It was a possibility that the competitor would price beneath the Council to gain market share. It was suggested that this had in fact happened and was a logical response of one competitor to another when the first kept increasing prices. This made the “loss leader” strategy of the competitor even more effective. There was one other crucial piece of information that was that the competitor   waited and did not enter the market immediately the new policy was enacted. This became an important dynamic when the simulation model was built.

The final stage of development of the CLD was the inclusion of the expense revenue and profit structures for both players. Both are faced with the same structures except that the Council has to bear the cost of the recycling. 

Figure 6: Completed Model

An important process can now be highlighted. As Council lifts its price in line with its social policy, the competitor also lifts its price. Both these actions will  decrease the total amount of garbage collected. This increases the level of re-cycling and drives Council expenses up and profitability down.

Figure 7: The shift of the cost burden

The reference modes make it clear that the Council’s strategy of combining social policy with competitive policy are fundamentally flawed. Increasing the price to convert to recycling is counter-intuitive to its policy of using competition to produce efficiencies in the market place.

The Simulation Model

From the CLD developed in the seminar, a simulation model was built in “iThink” and then it was possible to incorporate data sets based on post hoc knowledge. 

The first was a delay in the competitor’s entry to the market. The competitor entered the market when two conditions were satisfied. Thus a profit of 20c per unit could be made and the Council could be undercut by 20c per unit. This was contained in the logic statement.

Private_Price = if (Council_Price>69) then (Council_Price-20) else (0)

Once the Council was charging more than 70c per unit, the competitor entered the market with a price of 50c.

The second was the rate of change from garbage to re-cycling. Given 1000 residents, free collection (0c cost) would not convert anyone. At a cost of $1, residents would be recycling 70% of their garbage.

The third was that the competitor gained 60% market share on entry to the market and this stayed constant.

The fourth was that Council price rose from 30c to $1 during the year. Collection costs were 30c per unit while recycling costs were 15c.

Findings and Model Outcomes

With these variables in place, it was possible to run the simulation and examine the outputs.

 
Figure 8: Entry of competitor
 
Figure 9: Relative Profitability
 
Figure 10: Changes in revenue and expenses
 
Figure 11: Relative collection and re-cycling

Figure 8 shows the delayed entry of the competitor into the market and that prices rise in parallel. Figure 9 shows Council profitability declines throughout the period but more rapidly once the competitor enters. Figure 10 shows why. Council Revenues are increasing as the price goes up and expenses are declining as the residents switch to the less expensive recycling process and the operation has positive cash flows. However, this changes with the entry of the competitor when the Council loses 60% of its market. After that, it consistently loses money. Figure 11 shows that relative collection and recycling rates. When the competitor enters the market, residents switch back to collection as a preferred option but this changes over time as both Council and competitor lift their prices. The final recycling rate is 69%

As a result of this policy, the Council is losing money while the competitor is making it, 70% of garbage is being recycled and the residents are paying either 80c or $1 per unit for garbage collection. Given the unprofitable nature of the Council operation, a drop in local taxes to compensate for the costs of a privatised garbage collection, appears unlikely. 

In summary, the recycling policy appears to have been successful but the privatisation/rate reduction has not. The reason for the second is that the success of the privatised garbage collection is dependent on the dynamics of the competitive environment. The Council had to bear the costs of the recycling operation and once it lost market share, it no longer had the revenue to support this operation. In addition, it had been assumed that garbage collection would have been attractive to private investment. However, the Council had its infrastructure in place, particularly in the form of collection trucks. The competitor needed to get a return on the capital investment needed to move into the market, hence the wait until the market, dictated by the price charged by Council, became profitable. Once the competitor was in the market, their pricing ensured that they captured 60% of it and the Council, burdened by the costs of a steadily increasing recycling operation, was never going to be profitable.

Policy options

If Council sets its price at 65c to begin with and leaves it there, the outcomes are:

Figure 12: Keeping the competitor out

This scenario is based on the knowledge that the competitor enters the market at 70c, so pricing is used as a tactic to deter competition. The residents pay 65c per unit, which is an improvement on the best price offered by the competitor in the previous scenario, the recycling ratio is 65%, down 4% and the Council makes a modest profit. But there is no competitor in the market to produce the efficiencies of competition.

If the Council sets its price at 70c and holds it there, the following results are achieved.

Figure 13: Effects of price at 70c.

Council can no longer run a profitable operation. However, the competitor can. Residents are paying 70c per unit and the recycling rate is down to 58%.

There are a number of policy options that can be explored. One is making the competitor collect recyclable garbage. The response to this would be, predictably, to charge for the service and put the price up to a point where it is profitable. This would compromise the recycling policy. Another option was to increase the costs to the competitor for using the Councils garbage tip. However, this was discriminatory and unlikely to be legal. 

Conclusion

In this situation, therefore it seems that the dynamics of the social policy concerns for recycling and the economic concerns for the efficiencies of private enterprise create a situation where it impossible for the Council to compete effectively. Perhaps it is indicative that when Government instrumentalities enter the market-place, they need to shed their regulatory mental models. They are moving from a world where they can regulate and legislate to increase their chances of achieving their desired outcomes. In the private sector, they do not have this ability. In this case study, it is the actions of the competitor, whose sole motive is profit, and not the Council, that determine the dynamics, and the success of Council policy, in the maall markeplace.

The case demonstrates the difficulties that arise when the planning of major strategic change such as the move to privatised services does not take into consideration complex dynamics over time and the impact of feedback. All the information for building the simulation model existed in the participants in the workshop. All that was needed to see the counter-intuitive outcomes of these policy decisions was a process that was able to put that knowledge into an interactive model incorporating time based feedback. Without that capability, it is impossible to develop a range of policy options that may avoid the political embarrassment involved in this situation.

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