Sector fragmentation and aggregation of service provision in the water industry

This study analyzes the structure of the water industry in Peru. It investigates economies of scale and cost inefficiencies in 43 water providers during the years from 1996 to 2005. Different water sources in different geographical regions directly affect the production technology of the sector, making a regional cost frontier model appropriate. In 2005, 48.7% of the population of Peru lived in poverty, and 43.87% of the water produced was lost. These large proportions support the assumption that water producers allow water to be lost as a way to satisfy the water demands of the poorest segment of the population. Findings indicate a cost rise of 0.10% for each 1% increase of joint production of both outputs: water lost and produced. This result may be suggestive of a price the utility pays for allowing unauthorized connections in the network. From the perspective of the board of directors, this cost increase is the political cost of gaining municipal votes from the poorest segment of the population. Economies of scale are larger for utilities operating in the forest than in other regions. This has important implications for any future consolidation process that may be undertaken when the sector is opened to private participation.