Costing Government Services: Benchmarks for Making the Privatization Decision

By Rose, Pete | Government Finance Review, June 1994 | Go to article overview

Costing Government Services: Benchmarks for Making the Privatization Decision


Rose, Pete, Government Finance Review


An analysis of all avoidable costs, including indirect as well as direct expenditures, was the basis for deciding whether to contract out yard-waste collection services in Upper Arlington, Ohio.

Governments are coming under pressure to do more with less. Taxpayers are becoming more reluctant to approve tax increases, not only making it difficult to add new services but sometimes making it difficult to continue current service levels. Many governments are turning to the private sector for the delivery of services in the belief that savings could result by contracting out services currently being provided by the government.

If a government wishes to contract out a service, how does it know whether any savings will result? The methodology described in this article was used by Upper Arlington, Ohio, to evaluate proposals for the collection and disposal of yard waste. The city council had directed the staff to solicit bids from the private sector for this activity, and the challenge was to evaluate the bids to see if the approach was cost effective.

The Case of Yard Waste Separation

Upper Arlington, with a 1990 population of 34,128, is the largest suburb in the Columbus, Ohio, area. The city is a bedroom community, with more than 95 percent of the land use devoted to residential housing, either single family or multi-family. The remaining land use consists of retail establishments and professional offices.

Due to state legislation mandating that yard-waste material be removed from the waste stream that goes to landfills, Upper Arlington required yard wastes to be separated from other solid waste beginning in February 1992.

The city provides solid-waste collection and disposal services for residential units only. Commercial enterprises must make their own arrangements for the service. The collection and disposal of yard waste had been provided by the Solid Waste Management Division within the Department of Public Services. There was one full-time employee, assisted by a part-time employee during the spring and summer. One vehicle was used for the collection and disposal of yard waste, and collection took place on a weekly basis. The city council wanted to know if it would be more cost effective to contract the service out to a private firm.

In order to determine whether or not the service should be privatized, a two-step process was utilized. The first step was to determine the total cost of providing the service. Ideally, costs should be analyzed over a period of years and updated based on current costs and service levels. Determining the cost of the service establishes the benchmark. The second step was to analyze the costs to determine if privatization would be more cost effective.

Costing the Service: The Benchmark

Upper Arlington staff used annual expenditures for establishing the benchmark. Shorter periods could have been used if there had not been the possibility of seasonal fluctuations. Using annual expenditures, however, eliminated this problem. Similarly, prior-year costs were reviewed to ensure that service levels had been consistent over time.

The five-step process used by Upper Arlington officials to determine the cost of providing the service consisted of the following:

1) analyzing total city expenditures to determine which costs should be considered overhead,

2) determining which costs have to be allocated indirectly,

3) determining the method for allocating overhead and indirect costs,

4) determining the direct costs of providing the service, and

5) adding the overhead and indirect costs to direct costs to obtain total costs. The five steps of the cost-calculating process are described in the sections that follow.

Determining Overhead Costs. In order to provide services to the public or to customers, some level of administrative support is required. To determine the total cost of yard-waste service, Upper Arlington officials began by identifying support and administrative functions and their associated costs, commonly called overhead. …

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