Beyond The Leaky Tap: Performance-based Contracts For Non-revenue Water In South Africa (Part 1)

South African municipalities lose vast quantities of treated water before it reaches customers. Water lost in such cases is referred to as non-revenue water (“NRW”). NRW includes physical water losses through leaks and burst pipes; commercial losses from metering inaccuracies and theft; and unbilled authorised consumption such as free basic water (“FBW”) allocations. NRW in South Africa has risen from approximately 37% in 2012 to over 46% in 2022, with 70 out of 113 water services authorities reporting NRW figures in excess of 30% (Graham N et al, p iii). The scale of the problem implicates not only infrastructure and technical capacity, but also the regulatory and procurement frameworks within which municipalities operate.

The underlying causes and their regulatory significance

The causes of NRW are fundamentally interrelated. Technical losses arise from poor maintenance and inadequate asset replacement. Commercial losses arise from insufficient funding for meter replacement, inadequate meter reading capacity, weak local governance, and poor billing systems. Together, these operational issues often point to deeper institutional problems that need innovative technical, financial and regulatory solutions.

To address NRW, performance-based contracts (“PBCs”) have been proposed as a means of leveraging private-sector expertise, with payment tied to measurable outcomes and deliverables rather than inputs. In other words, work done must translate into measurable improvements. Although not an entirely novel concept in social infrastructure development globally, PBCs have been tested minimally in the South African municipal water context and have not been adopted at scale.

Two key barriers to scaling PBCs

Research identifies two overarching reasons why PBCs have not scaled in South Africa. First, the risks to the private sector have been too high, limiting market appetite. Beyond the standard performance risk that projected savings may not materialise, contractors face a range of local political and operational restraints such as contract repudiation, payment risks, partnership risks (for instance, inadequate municipal cooperation), and data quality risks. Where municipalities cannot manage these risks, contractors seek to price them into their bids, rendering contracts unaffordable. Alternatively, contractors decline to participate altogether.

Second, some municipalities may lack the skills and experience to structure and manage PBCs within the existing regulatory landscape. The responsibility for addressing leaks typically rests with technical managers who can appoint repair contractors but lack the authority to commit a municipality to multi-year performance arrangements. As a result, it may prove difficult for such managers to secure the required administrative and political approval. This difficulty arises from unfamiliarity with the contracting model and concern that PBCs may trigger other procurement requirements, such as those provided for in Chapter 8 of the Local Government: Municipal Systems Act 32 of 2000 providing for service delivery by external mechanisms, or regulations governing public-private partnerships (“PPPs”), which require substantial operational and commercial risk to be transferred to contractors under the Local Government: Municipal Finance Management Act 56 of 2003 (“MFMA”) and related regulations.

The procurement and regulatory dimension

The goal of any NRW programme should go beyond reducing debt. It should aim for a well-managed water network that supports a lasting relationship between a municipality and its customers.

It is the intersection with South Africa’s procurement regulatory framework that warrants closer examination. A PBC’s classification determines which regulatory approval pathway applies. If the PBC is categorised as a PPP, the contract triggers substantial consultation and approval processes under the MFMA’s PPP Regulations. If the PBC is an external service delivery mechanism, the contract triggers requirements for consultation, feasibility studies and council approvals under the Systems Act. Even where a PBC is not classified as a PPP or an external service delivery mechanism, it may still engage the Municipal Asset Transfer Regulations if the contract involves the use, control, or management of municipal capital assets. Another factor to consider is that municipalities frequently cap contract durations at three years to avoid the requirements of section 33 of the MFMA, which governs contracts that carry future budgetary implications. However, longer durations of three to seven years tend to yield greater water savings.

Research suggests that PBCs are most appropriate for municipalities that sit in a gap between two extremes: well-performing municipalities that can address NRW more cheaply in-house, and distressed municipalities that present unacceptable risk to contractors. PBCs should, in theory, be viable for municipalities with sufficient financial liquidity and contract management capacity to honour the contract, but which lack the internal technical capacity or incentives to address NRW themselves.

Engaging the underlying issues

The relationship between PBCs and South Africa’s procurement regulatory environment is multifaceted. It engages questions of procurement strategy, the MFMA’s budgetary and approval requirements, supply chain management regulations, the Municipal Asset Transfer Regulations, and the interplay between contract design choices and regulatory requirements. These issues cannot be addressed adequately in a single article. The various types of PBCs, from design-build-operate-maintain contracts to incentivised programme management arrangements, each have different regulatory implications that affect the degree of risk transfer between municipalities and contractors, contract duration, and the municipality’s existing capacity.