Strategy for water pump maintenance in Peakland

Peak Time preliminary round case

Disclaimer: all data is fictional, yet based on real life business patterns

Case study prepared by Civitta Analytics & Management Consulting

www.civitta.lt

The company: PeakWater

State owned water supply company...
PeakWater is a state owned company providing integrated water systems for the citizens of Peakland. Integrated water systems include Water supply, Sanitation, and Wastewater treatment The company was established in 2002, when the ruling government made a decision to merge all local municipality water utility companies to achieve economies of scale and introduce more modern management and investment practices So far, PeakWater has mostly lived up to the expectations and cut on costs. Water quality has been improved thanks to extensive investments in water sanitation facilities

...which faces efficiency issues

However, water supply disruptions have become more prevalent. Planned disruptions grew continuously in duration and caused discontent among citizens for their bad timing. Moreover, supply system failures caused by unfavorable external circumstances have become more frequent and are taking longer to liquidate. The management of PeakWater has been attributing the above problems to the aging of the water supply infrastructure and to insufficient levels of investment to renew it

In 2010 it was revealed that FixIt, a subsidiary responsible for the maintenance of the water supply system, may be highly inefficient and may prevent PeakWater from improving water supply services
Service downtime, minutes, 2006 - 2010
4,380 4,672 5,256 5,548 6,132

Peakwater profit, millions of currency units, 2002 - 2010

-45 -153 -150 -144 -136 -24 -4

-167

-166

2002 2003 2004 2005 2006 2007 2008 2009 2010

2006

2007

2008

2009

2010

(2)

FixIt: water pump maintenance

When PeakWater started operations as a merged company in early 2002, all maintenance activities were carried out by the companys own resources. These maintenance operations include: - Repairs of water facility - Repairs of water pumps - Repairs of real-time decentralized treatment doser - Operative help in the event of a water shortage In 2007, the government advised that all maintenance activities for utility companies should be separated from their core activities, hence, outsourced, in order to control costs and encourage savings through efficiency improvements. A few months later, in 2008, FixIt was born as a subsidiary of PeakWater. FixIt was given all the employees and assets which were used in maintenance, in return for a 100% holding of its shares. This meant that now PeakWater would buy maintenance services from FixIt. In theory, PeakWater could carry out public tenders to choose the best contractor, however, to date PeakWaters managers have chosen to purchase almost all maintenance operations from FixIt in order to ensure that FixIt received a constant revenue flow. At first this seemed like a success: maintenance costs dropped immediately after the separation of FixIt. In addition to maintenance activities, another extensive activity by PeakWater is investment projects, such as laying new pipelines , renewing old ones, or building new pumps and reservoirs. Most investment projects are contracted through public tenders. In 2010 FixIt decided that it should also start entering these tenders. It immediately became apparent that FixIt is uncompetitive the prices they could offer for investment projects were 20-30% higher than those of other contractors. PeakWater is concerned that if FixIt is that inefficient for investments projects, it might as well be underperforming in the maintenance work on which PeakWaters performance heavily depends. Moreover, if FixIt continues to lose all bids on investment projects, it will never ensure proper funds for improving their operations.

PeakWaters maintenance costs, millions of currency units

PeakWaters investment projects, millions of currency units

215
2005

216
2006

216
2007

166
2008

172
2009

171
2010
External contractors

400
2005

337

369
2007

493
2008

453
2009
(3)

452
2010

2006

FixIt (before 2008 - PeakWater itself)

What should PeakWater do with its maintenance work? There are several strategic alternatives
Alternatives for PeakWaters maintenance activities

Purchase maintenance contracts in the open market FixIt should compete with other companies: more incentive to improve

Privatisation of FixIt

Enforce restructuring of FixIt to increase efficiency PeakWater has little competence to improve FixIt, however, any efficiency gains would benefit PeakWater directly

Insource Fixit, reintegrating it back to PeakWater

PeakWater would get some revenue and the new owner would be eager to make FixIt more efficient

Since FixIt is critical to the success of PeakWater, the company should closely watch these activities and ensure necessary support

Keep in mind: Continuous supply of water is crucially important to municipalities water supply outages pose a substantial political risk Emergency service needs to be operational 24/7 - some accidents have to be dealt with as soon as they happen Both PeakWater and FixIt have inherited an old-school type of thinking. Employees are very reluctant to adapt to changes in the market and say that the company has been operating well enough and that it should remain so A private equity company has expressed an interest in adding FixIt to its existing portfolio of similar companies, which would increase the risk of market monopolization

(4)

Your task
PeakWater shareholders have hired you to consult them on what to do with the water pump maintenance function (currently performed by FixIt). Your task: Examine the situation and the possible solutions Propose your solution, identifying its pros and cons (your proposal may be one of the solutions suggested in this presentation, or one that you have come up with yourselves) Identify the next best alternative to this solution Explain why your solution is better than the identified alternative Solve a mini-case: what impact would this solution have on the company, as compared to the base case (doing nothing)? You must use the template provided. Please see further instructions on the front sheet of the template. You will be evaluated based on these criteria:
How clear and to-the-point your proposed solution is Argumentation of your proposal: well identified merits and drawbacks Choice and argumentation of the next best alternative Arguments to prove that your proposal is better than the next best alternative

(5)

Supplementary information
The following slides contain additional details for the case. You are advised to use this information for your solution, where relevant

Investment activities in Peakland and around: competition overview

The CEO of FixIt, Mark Waterplumber, has been pressured to explain why FixIt can only carry out investment projects at such high costs compared to the competitors. He insists that investment projects require higher competences and more elaborate equipment than the regular maintenance work. Thus, according to Mark, FixIt is perfectly efficient in the usual maintenance tasks, even if it cannot carry out the investment projects at the moment. Reluctant to believe him, you have collected whatever data you could get about the companies which PeakWater has contracted over the past year for investment projects. Revenues from investment projects (millions of currency units), 2010; Market share in Peakland investment projects (%)
1,200 1,000 800 600 400 200 0 Company A In Peakland Company B In neighboring countries Company C Other companies "Market share in Peakland" 5% 28% 16% 52% 60% 50% 40% 30% 20% 10% 0%

Average revenue per project in Peakland, millions of currency units, 2010

30 20 10 0

Number of projects in Peakland

60

40
20 0

Company A

Company B

Company C

Other companies

Company A

Company B

Company C

Other companies

Note: although most investment projects are carried out by PeakWater (since it is the only water supply company in the country), there are occasional projects of a similar profile carried out by private industrial companies for their own needs.

(7)

Background information: P&L for PeakWater

-3% Maintenance CAPEX

571

562

550

548

533

519

215

216

216

184

185

186

-15%

Revenues OPEX Payroll* Maintenance* Other EBITDA Depreciation Profit/Loss CAPEX

2005 997.319 426.797 194.410 214.855 17.532 570.522 714.667 -144.145 571.135

2006 956.171 428.799 194.682 215.851 18.265 527.372 694.167 -166.794 561.620

2007 966.274 430.136 194.935 216.378 18.823 536.139 673.667 -137.528 550.111

2008 1,007.393 399.220 195.734 184.040 19.446 608.174 653.167 -44.993 548.034

2009 1,009.223 400.964 195.957 184.865 20.142 608.260 632.667 -24.407 533.289

2010 1,010.883 402.882 196.545 185.700 20.638 608.001 612.167 -4.166 519.112

*Maintenance for 2005-2007 includes payroll of maintenance function staff Note: all figures are in millions of currency units
(8)

Background information: P&L for FixIt

2008 Revenues OPEX 184.040 176.567 2009 184.865 184.270 2010 185.700 185.793

Payroll
Equipment Material cost Transportation Other EBITDA Depreciation Profit/Loss Income tax Net profit

85.423
13.532 23.546 3.643 50.423 7.473 2.393 5.080 0.762 4.318

84.062
16.851 27.34 3.954 52.063 0.595 2.393 -1.798 0.000 -1.798

85.313
16.432 26.865 3.842 53.341 -0.093 2.393 -2.486 0.000 -2.486

(9)

Water pump maintenance in neighboring countries

Organization of the maintenance business Service downtime, 2010 Material cost (maintenance, % of the maintenance companys revenues) 8% Maintenance services Profit margin

Danura

In-house engineering units in 3 largest residential areas

600 min

30%

Norevaea

Dedicated company subsidiary

5518 min

20%

5%

Cesabya

Strategic alliance with district heating companies joint multifunctional venture

1400 min

N/A (Cesabyas water supplier pays a yearly 250 million service fee to the strategic partner.)

15%

(10)

Background information - Peakland

Main economic indicators for Peakland and neighboring countries Indicator Area Population GDP Unemployment rate Inflation rate (CPI) Peakland 79k sq. km. 4.05m 106bn USD 10.1% 3.2% Norevaea 154k sq. km. 11.32m 231bn USD 13.5% 7.6% Danura 241k sq. km 19.93m 374bn USD 8% 2.2% Cesabya 530k sq. km. 31.53m 893bn USD 11% 3.1% Old Ogdenburg NOREVAEA

DANURA
Kenthunt

Mansshire Ridge
Mount Painesport

Millmore
Lower Centerburg

CESABYA
Westlawn

Regions Old Ogdenburg Millmore Mansshire Ridge Mount Painesport Lower Centerburg 604 554 243 235 337 299

Population 1,293 730 638 1,598

GDP per capita, USD 33,774 28,740 21,850 20,874 19,880

Unemployment rate, % 8.3 9.2 11.3 11.0 16.2 15.3

Westlawn 193 225 Kenthunt 174 227

City Suburbs

20,197 25,030 8.3

(11)