How-to Tips for Successful Landfill Privatization

Local governments face increasing regulatory costs in owning and operating landfills, as well as evermore difficult challenges in finding politically acceptable locations for new facilities to replace old ones or accommodate new landfill growth. Many governments have responded to these regulatory and siting challenges by privatizing their landfills.

The following how-to guide will help public officials through the privatization process–utilizing real-world case studies in learning both what to do and what not to do.

By Geoffrey F. Segal

Service Approach

Citizens need and want safe solid waste disposal services. They want it collected, hauled away, and properly disposed of without risk to themselves or the environment. As former New York Governor Mario Cuomo suggests, "It is not government’s obligation to provide services, but to see that they are provided."

There is a distinction between a government that provides a service and a government that produces a service. It is also the distinction between administration and management. Under privatization, government does not cease to administer, nor does it cease to manage, but it administers by vigilantly managing the production of services it buys from the private sector. Potential efficiencies may be forgone if public officials attempt to micromanage service delivery. Effective privatization requires a focus on desired outcomes without specifying how the outcomes are to be accomplished.

Selection Process

Local governments as a whole have substantial privatization experience. Once the available options for privatization are analyzed, cities that decide to privatize must select the process by which their solid waste systems will be privatized. Solid waste systems often include complicated, environmentally sensitive properties that operate under extensive regulation. Consequently, a simple request for proposals is not necessarily the best means to maximize the value of the system or to protect the city from future or ongoing liability.

Whether divesting or contracting services, governments are often moving away from a single-tier bidding process through which they simply select the lowest bidder. More often they are using a two-tier process that allows governments to examine bidders on multiple levels, with a focus on "quality-based" or "best-value" determinations. Officials in San Diego County, Fort Worth, and Indianapolis all used this process in privatizing their facilities.

RFQ Phase. The request for qualifications (RFQ) is used to assess the technical qualifications of potential bidders. The process determines a firm’s ability to meet basic performance, financial, and regulatory criteria. The RFQ is used to weed out applicants that do not meet minimal standards established by the local governing agency. These standards should broadly define the expected level of service required under the contract but should avoid micromanagement. When San Diego County sold its landfills, a major criteria in the RFQ was the financial stability and capability of the firm because the county had to know the firm could finance a deal of the magnitude it proposed, but the county did not tell the firm how to finance the deal.

Table 1. What to Include in Your RFQ

• Corporate Financial Ability
• Experience Providing Like Services
• Bonding Requirements
• Legal Encumbrances
• Indemnification
• Local and State Requirements
• Insurability
• Workers’ Compensation Issues
• Labor Issues
• Recordkeeping/Reporting Ability
• Accounting Practices
• Complaint-Resolution Procedures

Source: Lynn Scarlett and J.M. Sloan, Solid Waste Management: A Guide for Competitive Contracting for Collection, Reason Public Policy Institute How-to Guide No. 16 (Los Angeles: Reason Public Policy Institute, September 1996).

After the RFQs have been returned, they must be evaluated, reviewed, and ranked. Only firms that grade as adequate, good, or excellent should receive invitations to bid. The quality ranking should reflect the firm’s ability to incorporate innovation into operations. Firms that display good compliance/inspection and complaint/resolution histories should also receive high-quality points. Another factor that influences quality points is whether firms have been good corporate citizens–whether they get involved in the community, support charities, work on quality-of-life issues for their employees, and so on.

RFP Phase. The request for proposals (RFP) or request for bids (RFB) is used to select the winning contractor. It is important to have several bidders to ensure flexibility and choice: multiple bids ensure a competitive process, which in turn creates incentives to innovate, keeps costs low, and maintains high accountability. Sometimes smaller communities have trouble attracting multiple bidders, in which case joining with other communities to create larger and more attractive contracts can help. Another option is to form a public/private partnership with a firm that is not fully qualified on its own and develop it to a point where it can bid competitively for the job.

The RFP may be a single fill-in-the-blank page, where the contractor fills in prices or costs. But other very important factors besides price should be considered. Many factors are difficult to quantify, but the use of a "multiplier" may allow for their consideration. For example, price bids from firms that received excellent rankings in their RFQs might be multiplied by 0.9, while bids from firms with adequate rankings are multiplied by 1.1, and those from firms with good rankings are multiplied by 1.0. Using a multiplier enables government managers to consider the best combination of price, quality, and delivery options (innovation). The multiplier has the same effect as does lowering the cost of a bid from an excellent firm while raising the cost of a bid from a firm with a lower ranking.

A good strategy is to involve bidders in determining terms of the RFP and, later, the contract, especially the scope of work, performance standards, accountability, and employee transitions. Often the contractor will have more experience with such issues than the city or county does. Bidder participation also makes it easier to be sure that all necessary elements of service delivery are included in the RFP. Adding service changes after the selection–or worse yet, after the contract is signed–distorts the competitive process and can often be costly. Bidder participation also creates a level of trust with the contractor, which makes for better relations in the future.

Transfer or Contract Negotiations

Once the winning bidder is selected, the most difficult and important phase of the process begins: negotiating the sale, lease, or operational contract. Government officials should negotiate the best deal for taxpayers, in terms of both cost and service quality, while creating a viable partnership that benefits the vendor. Also, successful privatizations usually include steps to inform the public and answer their questions and concerns. If officials are forthright about how their decisions are reached and provide full access to the same information they used, some constituents may disagree, but they will have to respond with the same level of information. A sound information program can often win over unexpected allies.

Whether a government chooses an asset sale, a lease, an operational contract, or some form of partnership, some common issues must be addressed.

Asset Sales/Leases

Legal Authority for the Divestiture. An asset sale or lease must be authorized by statute or charter. Sometimes a variety of divestiture options are available, and sometimes state law restricts the options. An early analysis of legal authority is essential, and plans to ask the legislature for an enabling bill may be necessary.

Availability of Landfill. Government managers should ensure that the needs of the community continue to be met through a "capacity guarantee." The last thing a city wants is to be shut out of a local landfill.

Ensure Low-Cost and High-Quality Service. Government managers should negotiate prices as part of the deal. This does not mean using price controls; rather, local governments must be good shoppers. Nor does it mean always taking the lowest price–quality does matter and might cost more. The contract should also include mechanisms to ensure postclosure funding.

Environmental Regulation Compliance. Contracts should include provisions requiring regular monitoring/testing for groundwater contamination, hazardous waste, and methane gas. The contractor should also submit to a general landfill inspection on a regular basis (e.g., three to five times per year). Compliance with all federal, state, and local laws and regulations should be used as a benchmark for minimal standards. Also, both parties to the transaction must understand any existing environmental liabilities and environmental problems and the strategy for coping with them. Finally, both parties have to coordinate the transfer of the many permits and licenses attached to the facility, including air and water discharge orders, land-use permits, environmental permits, and health permits.

Safeguard Lease or Sale Proceeds. To ensure that the proceeds from converting a city’s physical assets (landfill) into financial assets (payments) are not wasted, government managers can specify the use to which proceeds from such asset transactions can be put. For example, proceeds from asset sales could be treated like an endowment dedicated to a specific purpose, such as public safety or debt reduction. The principal might be invested, with only the earnings available each year for spending on the designated purposes.

Operational Contracts and Partnerships

Performance Standards or Objectives. Performance objectives spell out the desired result expected of the contractor, but the manner in which the work is to be performed is left to the contractor. Performance objectives give contractors the incentive (bonus or penalty) to enhance productivity, reduce costs, and improve service quality. They also shift much of the risk to the contractor, who is rewarded for productivity improvement and penalized for poor performance or rising costs.

The better the performance standards, the easier contract monitoring is. Performance standards should be written at the same time that the monitoring plan is developed, ensuring that no discrepancies exist between the two. "The plan should be quantifiable and specific and include reporting requirements, regular meetings with minutes, complaint procedures, and access to contractors’ records." High risk exists, even for minor problems, within solid waste disposal. Therefore, high-cost and high-control preventive monitoring techniques become a necessity.

Accountability and Monitoring. Firms should be subjected to continual monitoring. Contracts should include reporting and auditing requirements. Accountability ultimately lies with the contracting government; elected officials must retain full responsibility and control through the monitoring procedure. This process enables local governments to maintain quality, quantity, and cost of services. Although it is costly, efficient monitoring pays for itself by preventing overcharges and poor-quality performance from the start by recouping inappropriate outlays and disallowing payment for inadequate performance. At the same time, the monitoring process must be completed without micromanaging the contractor.

Governments should avoid employing those individuals who formerly managed the in-house operation as contract managers or monitors over the contracted operation. Even if these individuals are fully committed to fairly and objectively monitoring the contractor, the appearance of bias and conflict of interest can cause disagreements and even rifts to develop between the clients and the contractor.

Maintenance. The contractor assumes responsibility for general upkeep of the facility, ensuring its ability to receive acceptable waste.

Employee Displacement. With any transfer of service, some employee displacement may occur but can be minimized with proper planning. Public officials should plan for employee transitions from the beginning of the privatization process. Often contractors can hire many, or all, existing workers, and governments might wish to offer incentives to encourage that. In addition, plans can be made to move displaced employees to other departments, retrain them for other public or private jobs, offer early retirements, and so on.

Liability. Government managers might wish to have a contractor assume, and indemnify against, all past, present, and future liabilities. They should expect to pay more for this. That doesn’t have to mean less cost savings: As a rule of thumb, risks should be assigned to the party with the most ability and incentive to minimize them.

Term and Payment. Length of term is another important clause of an operational contract (or a lease). Most operational contracts are between three and 10 years long. Rebidding them on a periodic basis is one way to ensure competitive pressure to innovate and keep costs down. (Lease terms can run much longer.) Generally, longer contracts have the most favorable rates but may reduce cost savings and innovation potential from more frequent rebidding.

The compensation package and payment schedule should also be incorporated into the contract. Performance-based payments should be part of the package and will be a bit more complex than standard fixed-price payment schedules. One strategy is to structure the compensation in two parts. First, a fixed fee designed to cover basic facility operating costs and any maintenance and capital upgrades must be agreed upon. Second, a variable fee tied to performance against a basket of outcome measures may be developed.

Termination. Another "must" section details method of termination for noncompliance, nonperformance, or general breach of contract. It can be helpful to establish an escalating scale of specific sanctions that culminate in termination and to specify the use and structure of arbitration or mediation. Often contracts will include "termination for convenience" clauses, which allow either party to end the agreement without cause but requiring sufficient notice, usually 60-120 days.

Performance Bond or Other Surety. Bonds or other sureties ensure that contractors are capable of performing the service. If the contractor fails to perform, the city receives the bond to cover any damages and costs associated with replacement service provision. But government managers should also be cautious that financial guarantees are set only as high as necessary. If set too high, they might prevent some small but competent firms from participating and reduce the amount of competition or result in driving up the user costs bid by all participants.

Conclusion

With privatization, public officials become consumer advocates, not operations managers. As consumer advocates, they negotiate, or shop, in the market for the best deal for their constituents. The contract establishes standards and accountability. Expectations of penalties or termination for nonperformance or noncompliance help guarantee high-quality service. And expectations of bonuses or higher profits bring increased productivity and lower costs.

For some governments, getting out of the landfill business and becoming a customer allows the city to shop for the best value and relives officials of the day-to-day headaches of running a complex operation. While privatization is not a panacea, when done properly it can bring benefits to governments and their constituents.

Geoffrey F. Segal is a policy analyst at Reason Public Policy Institute and author of Landfill Privatization: Market Alternatives to Solid Waste Disposal.