What Should a Rate Study Cost?

I opened the mail ? another request for qualifications for a water and sewer rate study. This one was from a city, population approximately 10,000, located within a three-hour drive of my office. The document was 15 pages long ? bad sign, they?re looking for way more than they need.

The deal breaker ? it specified several kinds of liability insurance that a small rate setting specialty firm cannot get for a reasonable premium. I tossed the paper into my recycle box.

This article is about cost containment. However, fees should be no higher than No. 3 on your ?good rate analyst attribute? list. First should be the capability of the analyst to solve your rate setting problems.

Anyone can double your rates. But it takes a good rate analyst to double your rate revenues with a high level of confidence while creating a rate structure that is demonstrably fair to your ratepayers. Second on the list should be how well the analyst fits you, professionally and personally. Fees should come in third. This article will help you get a good rate analyst who fits you well and won?t cost you an arm and a leg.

This article will show you what drives fees upward. That will help you figure out what drivers you can eliminate and still get the services you need.

Keep in mind:

  • Every utility and every rate study is different from every other.
  • Fees should be commensurate with services rendered.
  • Services rendered should be appropriate for the situation encountered.

Buying rate study services can be likened to hiring a tax accountant. Your top priority should be getting an accountant who will get you every tax break worth taking. But if you have to pay an excessive percentage of your tax savings to the accountant you would be better off doing your own taxes.

In the rate setting arena it makes sense to do your own rate setting during most years. You should only call in the analyst when big or complex things are going on or it has been several years since your last rate study.

Back to the request for qualifications story; it didn?t actually end in the recycle box, yet. A few days later an engineering firm called and asked me to partner with them on that same rate study. I agreed. We worked up a proposal ? it took a week. We got selected as one of the top three responders. We attended an interview. We just knew we were the best team for the project. We lost to another engineering firm. Here?s the interesting part.

If this city had solicited simply, allowed each analyst to specify what needed to be done and did not require the extraneous insurance, I would have done this study for around $8,000 including one trip there to present my results and recommendations to their council.

Partnering with the engineering firm to respond as specified; adding their overhead, insurance and response costs; and then adding fees to cover my response costs pushed our proposed fee to $25,000.

The winning firm estimated their total costs at around $70,000. However, they were willing to cap their charges at $35,000.

Perhaps this city will actually get $70,000 worth of rate analysis but $8,000 would have bought what the city really needs.

Do you think the winning firm ?ripped the city off?? Slow down. Consider it from the proposer?s point of view.
The winning firm incurred costs (marketing and acquisition) just to get this project. Its costs included staff time, response production, travel (one member of the team flew in from Florida), etc. These costs may have totaled $5,000. If this firm wins one out of five such responses (a strong winning rate), the firm needs to make $25,000 ($5,000 times five tries) on this project to pay the acquisition costs. Add $8,000 for rate study work and $2,000 for additional profit and the total is $35,000. Thus, the fee is made up of acquisition costs; the lion?s share of the fee; rate study work and profit. The level of the fee is a direct result of how the city went about soliciting these services. The city got what it (perhaps unknowingly) asked for ? a very expensive rate analysis.

If your system is much smaller and simpler than the example city you will, of course, be looking at lower fees. But you could be looking at far lower fees if you will just solicit in a way that will allow proposers to keep their acquisition costs low. Following is a checklist of things to do. Some will sound like heresy but the explanations that follow the list should clear that up.

Ditch the RFPQ (request for qualifications and proposals). Instead, Decide what outcome you want to achieve. That should boil down to a simple statement like, ?We want our rates to be adequate to fund our utility properly for the long term while being fairly structured for our ratepayers.?

  • Gather some basic information about the system to be analyzed.
  • When you have the rate setting goals in mind and system information at hand, canvass prospects by phone.
  • Solicit responses only from those you determine to be rate analysts.
  • Require responders to carry auto, health and general accident insurance coverage, if you care to bother with it, but do not require liability coverage, often called ?errors and omissions? insurance.
  • Before hiring an analyst require an excellent guarantee and check their references thoroughly.

Ditch the RFPQ? Yes! You should not assemble pages and pages of requirements and specifications (expensive and time consuming on your part), mail them in a RFPQ to everyone you can find an address for, receive boxes full of response materials and have a committee wade through them for weeks trying to decide which firm would be the best to serve you. The more you specify about rate study techniques the more it will cost because you will always ask for things that are not necessary. A written rate study RFPQ, if you use one at all, should be about two pages long. Much more than that and you are unnecessarily running up your costs. Keep it simple.

If you don?t mail out a long written RFPQ, or even a short one, how then can you tell rate analysts what you want them to do? That?s just it. You don?t need to tell them what to do. In their responses they will tell you how they intend to conduct your analysis. Let them use all the rope they want to either climb to the top of the mountain or hang themselves. Don?t tell them ahead of time how to do the former and avoid the latter.

The trick to getting a great rate study at reasonable cost is not the RFPQ. It is finding one or more rate analysts to solicit. If you must have a RFPQ, just use it as your ?script? for talking with prospects on the phone. When you talk to a prospect you should first ask, ?How do you make money?? That will separate the analysts from the pretenders. If they are not a rate analyst there is no need to waste more of your or their time. You wouldn?t ask a lawyer to design a water tower, would you?

Continue talking with those you determine to be analysts, telling them your rate setting goals, project timeframe and such. To scope your project they will also need basic information drawn from sources like these:

  • Income and expense statement, balance sheet and balance trends,
  • Capital improvement and equipment replacement plans,
  • Current rate chart and rate adjustment history, and
  • Expected events that will impact the financial health of the utility.

Receive responses from analysts by e-mail. Phone and e-mail contact are how most facets of the rate study will be handled anyway so use them from the start. You can call prospects, solicit three or four rate analysts from among them, review their responses and call references using about a day?s worth of time. This method is quick, easy and cheap. ?

You might think that saving on acquisition costs is most important for large systems because there are large sums of money to be saved. The opposite is actually the case. A large system is likely to end up raising rates enough to generate, say, $1 million more each year. If the analysis costs $20,000 the payback period will be 7.3 days. That means the system will raise its rates and use 7.3 days worth of its extra rate revenues to pay the analyst. If the analyst charged $40,000 the payback period would still only be 14.6 days.

If, however, a small system ends up raising rates enough to generate $35,000 more per year and the analysis costs $3,500, the payback period will be 36.5 days. If the analysis costs $7,000, the payback period will stretch out to 73 days. Thus, $3,500 in extra fees for a small system is worth five times more to that system than $20,000 in extra fees to the large one. Fees are still only No. 3 on the small system?s list of analyst attributes, but they are a very strong No. 3.

Almost never should you hire a rate analyst on an hourly basis. Pay for results, not hours.

Finally, rate setting carries risk. You need protection against the risk of hiring a firm that may look good, but cannot deliver the goods. You should not do that with layers of expensive insurance coverage. Collecting damages from an insurance policy is a pain, it can be costly and it is not a sure thing. Besides that, the consultant is not paying those insurance premiums, you are. They only serve as the collection agency.

Instead of superfluous liability coverage you should require a guarantee from your responders that reads something like this, ?You will be satisfied or you pay us nothing.? You should also require extensive references and check references thoroughly. No one is in a better position than a past client to tell you if a rate analyst is good.

Now that you know how to eliminate extraneous fee drivers, what should a rate study cost your water or sewer system? The chart on page 35 depicts fees for analysis of one utility without the extraneous fee drivers. In the chart find the population range served by your system. To that fee add between $400 and $1,000 to pay the analyst to appear before your board or council to present their results and recommendations if they can drive there in a reasonable time. If they have to get on an airplane, tack on $1,500 instead.

Small systems frequently require no onsite visits. Seldom do they need more than one. Larger systems and those with multiple utilities being analyzed sometimes require two or even three visits. If there will be controversy about the rate adjustments, usually because they are going to be large, an on-site visit by the analyst is money well invested. It is better that the analyst take the arrows than you.

A cheap or even free alternative to the onsite visit is to have the analyst participate remotely by speaker phone. (Someday we may do this by online video conference or video phone conference even for small systems.) The upside to speaker phone participation is the analyst can do rates for any system anywhere without once leaving their office. The downside, for those of us who love to go face to face with naysayers as we ?educate? them, is that the speaker phone is not nearly so satisfying or ?educational.?

If you want the analyst to examine a second utility; for example, analyze water and sewer rates; you should boost the dollar figure in the fee chart by 75 percent before adding the travel costs. In other words, the second analysis should be about 25 percent cheaper than the first.

Finally, whatever dollar amount you got when you did the simple math above, subtract 20 percent and add 40 percent to get the range of fees that may be reasonable for your situation. Why subtract a little and add a lot? You are probably under-estimating, not over-estimating, just how bad your situation is.

To demonstrate the math above, consider the systems in the 1,000 to 3,000 (1-3K) population group. The average system in this group paid $4,105 for its rate analysis. It also got a $400 onsite visit which brought the total fee to $4,505. Therefore, a fee range of $3,604 on the low side (20 percent less) to $6,307 on the high side (40 percent more) would be reasonable for a system of this size located close to the analyst.
Spread over the five years that this analysis should comfortably carry such a system?s rates, this fee range is roughly equivalent to paying $721 to $1,261 per year.

From another perspective, a fee of $4,505 would cost each person in such a system 3.8? per month for five years to get and keep rates that are adequate for the system and fairly structured for the ratepayers. That?s a cheap cheeseburger once every five years.

You now know how to estimate the range of fees you can expect to pay for a rate study if you will eliminate the extraneous fee drivers before soliciting analysts. If you will make these simple changes you might reduce the fees you have to pay by 50 percent or more compared to traditional solicitation methods. More importantly, your rate setting results are bound to be better. The key to getting these results is not ?holding out? for the right fee offer. The key is soliciting properly so prospective analysts can deliver what you need at the right fee.

You can get the right rate study at the right fee that will give you rates that are right for your system and right for your ratepayers, if you will just do it?right.

Author?s Note: Fee data and information referenced throughout this article is from the author?s practice. Some might view this information as promotional. However, it has been cited here as a means to educate, not promote.

Carl Brown is President of Carl Brown Consulting LLC, specializing in water, sewer and storm water system rate analysis, asset management and training nationwide; and GettingGreatRates.com, home of many rate setting tools. Contact: (573) 619-3411; E-mail carl@carlbrownconsulting.com or at http://carlbrownconsulting.com/.

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