Estimating Economies of Scale and Scope in the English and Welsh Water Industry Using Flexible Technology

Abstract

Estimating the presence of economies of scale and scope is essential to support restructuring policies aimed at increasing the efficiency of the water industry. This paper demonstrates the usefulness and advantages of using a flexible technology to estimate economies of scale and scope in the water industry. The empirical application focuses on the English and Welsh water and sewerage industry, where companies offer a variety of services; water and sewerage companies (WaSCs) and water-only companies (WoCs) are two common business models within the industry. In this paper and for the first time, a flexible technology model is estimated that allows for type-specific technologies using a quadratic cost function to analyze the cost properties of water companies providing different services. The results do not support a common technology for WaSCs and WoCs. Thus, a flexible technology approach may be preferred for a reliable analysis of cost properties of WaSCs and WoCs. The results also show that the existence of economies of scale for WaSCs and WoCs, as well as integration economies between water and sewerage services, could potentially create substantial cost savings. The methodology and results of this study are of great importance to both companies and regulators to facilitate informed decision making in terms of optimal industry configuration and possible unbundling reforms.