At the Danish Water Regulatory Authority, we work to ensure that water and waste water companies become more efficient all the time.
Benchmarking is used to set revenue caps and annual efficiency requirements. This contributes to lower water prices, higher consumer welfare and enhanced competitiveness for water-consuming companies and thereby growth in Denmark.
The water sector is characterised by natural monopolies. This means that the sector is not subject to the competition that leads to more efficient operations, lower prices and better quality in a well-functioning competitive market. Benchmarking contributes to artificial competitive pressure in the sector.
In our benchmarking we compare the efficiency of the individual water companies. Against this background, we set individual efficiency requirements for the least efficient companies. The level of the individual requirement reflects the efficiency potential of the individual company compared to other companies in the same sector. In this way, the least efficient companies are encouraged to use their resources as well as the most efficient ones.
We benchmark the finances of the water companies in an overall financial benchmarking model that includes the companies' costs for both operations and investments. The benchmarking result forms part of the water companies' financial framework (revenue caps).
The individual benchmarking-based efficiency requirement must be seen in the context of the general efficiency requirement.
Who is benchmarked?
Water companies that charge for more than 800,000 cubic metres of water per year are benchmarked and may therefore be given an individual efficiency requirement.
In our benchmarking we distinguish between water and waste water companies. Benchmarking is staggered between the water and waste water companies, so that the water companies are benchmarked in even years, while the waste water companies are benchmarked in odd years. Water companies with a charged volume of water less than 800,000 cubic metres may voluntarily choose to participate in the benchmarking. However, the result of the benchmarking for the smaller water companies will not have an impact on the company's financial framework.
Water companies wishing to participate in the benchmarking must notify the Danish Water Regulatory Authority by 15 March. A basic fee is charged for participating in the benchmarking – whether or not the benchmarking has been chosen voluntarily or not. The fee is calculated on the basis of the total volume of water charged for all water companies that are benchmarked and is evenly distributed
Benchmarking method – how we do it
Overall financial benchmarking consists of benchmarking that compares the operating and construction costs of water companies to determine their individual efficiency requirements.
Overall financial benchmarking (TOTEX) consists of two parts: Operating costs (OPEX) and construction costs (CAPEX). In our benchmarking, the water companies are compared on how efficient they are at running their companies in relation to the others in the sector. That is, the operating and construction costs of the water companies are compared to the average costs in the industry.
We use a method that includes two different models to determine the efficiency potential of each water and waste water company. The two models are a Data Envelopment Analysis (DEA) and a Stochastic Frontier Analysis (SFA) model. Both models are recognised and widely used as benchmarking models.
DEA and SFA are two different methodological approaches for identifying the efficiency potential of water and waste water companies. As a precaution, we combine the results of the DEA model and the SFA model in a best-of-two approach. This means that each water company is assessed in both models. The efficiency potential of each water and waste water company is based on the model that calculates the highest efficiency score, which is therefore the most favourable for the individual water and waste water company.
The most important steps in benchmarking:
- The companies report information on operations (underlying relationships with cost drivers) and investments (list of assets) as well as actual operating costs and investments. These reports are quality assured and corrected if necessary.
- Based on the quality-assured information, the two net volume measurements (OPEX and CAPEX) are calculated, which express the company's activities and assets. In order to correct for any expensive operating or investment costs due to old fixed assets and/or fixed assets subject to a complex infrastructure, alternative net volume measurements are calculated.
- The water companies are benchmarked on their net volume measurements and their actual costs to identify the most efficient companies. Actual costs consist of the sum of operating costs, depreciation and financial costs.
- Immediate efficiency scores are calculated for the companies. These are ranked on a scale from 0 to 1 and describe how efficient a water or waste water company is. The most efficient companies have a score of 1, which converges to zero as a company’s efficiency falls. Under special circumstances, the immediate efficiency scores are corrected. This adjusted efficiency score is used to calculate the companies' efficiency level. The efficiency level is the cost level that each company should have in order to be among the most efficient. The efficiency potential is calculated as the percentage difference between the company's revenue cap from the previous year and the efficiency level. As a precaution, this cannot exceed 16 per cent of the revenue cap from the previous year.
- The efficiency requirement is the efficiency potential in DKK. Efficiency requirements are calculated on the basis of the efficiency potential. Efficiency requirements are deducted from the financial framework of the water companies.
Historical changes of method
The overall financial benchmarking model (TOTEX) consists of two parts: Operating costs (OPEX) and construction costs (CAPEX). This page contains information on the introduction of construction costs and hence the transition to total financial benchmarking (TOTEX) and the revision of the elements for operating costs (OPEX).
TOTEX benchmarking models
In 2016, we went from only benchmarking operating costs to total financial benchmarking (TOTEX) which takes into account both operating and investment costs.
As part of this, the Danish Water Regulatory Authority published a report (in Danish) on proposals for TOTEX benchmarking models for the water sector produced by the consultancy company Copenhagen Economics and Professor Peter Bogetoft. The report describes how the proposal for the model was developed. We note that the report contains proposals that we have subsequently revised and expanded in dialogue with the water companies and industry organisations.