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Working paper

Parametric and nonparametric cost efficiency benchmarking of water utilities in Russia

The activities of the water companies in Russia are regulated in order to overcome market failures caused by regional monopolization, information asymmetries and the need to find a balance between the interests of consumers and company objectives for its normal functioning and development. In the Russian Federation, the regulator uses the outdated and inefficient cost method, which deprives the company an incentive to reduce their own costs. However, Russian regulator is in active discussion about the transition to modern long-term management regulation practices in order to increase companies’ efficiency, which in the framework of the regulation defines the future of the company's profits. Russian regulator should take more active steps to encourage regulated companies to increase efficiency and productivity. Solution is to move to using benchmarking, which allows to identify sources of companies’ inefficiency to assess the validity of the established tariffs. This study presents the first attempt to implement benchmarking methods used by the world's leading regulators to determine the cost efficiency of companies and improve their potential. The authors tested a parametric (COLS) and non-parametric (DEA) methods to assess the performance of companies with different technical and economic characteristics more accurately. The study makes a number of recommendations for the specification of the model, assessing its sensitivity to the changes in samples. The authors concluded that the model based on COLS is of high quality and resistance to changing of sample while assessing the technical efficiency. However, a similar statement for DEA models is unfair, since the inclusion in the analysis of either too large or too small companies does not lead to plausible results. On the other hand, DEA allowed to assess not only the technical efficiency of companies but also the allocative one. In general, the authors have shown that the potential for increasing the efficiency of Russian water supply companies is large enough, and the regulator is necessary to accelerate the transition to incentive regulation in order to increase efficiency in the sector.