The Square Deal in Water Works Valuation
Equitable Method of Valuation of a Privately Owned Water Company—Consumers Will Pay a Fair Rate on a Fair Valuation
THE question of proper valuation of a water company and the most equitable way of going about it so that all concerned will receive a square deal, is not always an easy one to answer. Mr. Lambert’s ideas will be found of value in this connection.
Of all the valuations which this firm has made, about seventy-five per cent, have been made for the city and twenty-five per cent, for the company. In a few cases, we have represented both sides jointly. On account of having represented the cities in so many cases, I believe that some idea of a valuation and its relation to the municipality will be of interest.
Almost invariably, a valuation has a relation to the municipality. I presume that in ninety-five per cent, of the cases where a valuation is made of a public utility it is made to determine a fair rate to be charged for the output of the utility, or to determine a fair price for the purchase of the property. In both cases the municipality is vitally interested.
Consumers Willing to Pay Fair Rate
I have found almost universally that the consumers of a utility are willing to pay a rate which will give to the utility a fair return on a fair valuation. Of course, there are radicals in many communities whom it is hard to convince that anything near an adequate return is fair, but for the most part, these are a small minority. The attitude of the public toward a utility is, of course, governed largely by two things. The first of these is the service rendered and the second is the attitude of the local management toward the public. A local manager has a great many things to contend with and a great many unreasonable complaints to meet, but if he will show the public that his company (and to most of the public he is the company) means to give them service and courtesy, he will do more to get an adequate rate than in any other way. A local manager of a gas and electric property in Missouri recently expressed that in what to me seemed a very forceful way. He said, “I keep in mind that I am not trying to sell the public gas or electricity— I am trying to sell them service.”
Fair Valuation from Public’s Standpoint
The question then is: What, in the mind of the public, is a fair valuation? You will find that to the average city official or interested citizen, the first thought that occurs when the subject of a valuation is broached, is the question of “Going over the books.” To those to whom the subject of valuation is new, it does not occur at first to have a complete inventory made, but they believe that the value of the property will be reflected from the records.
I believe that this is due to two reasons. First, the average business man determines the value of his business largely by the amount of his stock which is shown by his books.
He does not realize that, whereas in his business probably his big investment is in what he sells and not in his means of selling, in the utility the big investment is in the means of selling and not in the goods sold. Second, I believe the average citizen feels that the fair value on which a return should be made is the actual investment, and he believes that this can be obtained from the books. I mean to touch on the question of what is fair value, which has been much discussed, only so far as it relates to the opinion of the citizen. We can see how the average man would look at this, and I believe that the average utility company itself would be satisfied if it could at all times receive a rate which would pay its operating expenses, take care of depreciation and then leave sufficient money to pay a fair return on the actual investment, where the actual investment represents the actual reproduction or original cost.
Necessity for Company Inventory of Appraisal
While the actual investments seems a simple matter to obtain, we all know how complicated the path becomes when we try to trace it back, especially in a company which has changed hands several times. Then, again, very frequently the actual money invested represents a sum which was used to purchase a property at a forced sale and docs not represent the true value of the property. This is a matter which sometimes is difficult to explain to the citizens—why a company is entitled to a return on the value of a property above that which they actually paid, as in the case mentioned above. This is one of the important reasons in favor of a real inventory and valuation. Again, the books sometimes do and sometimes do not show property which has been superceded and removed. If the actual investment is to be used, this should be given consideration, yet, it may not be shown on the books. Again, the books may be based on a previous valuation and not on the actual investment. As stated above, we believe one reason an accounting of the books is first considered, is because it is desired to get the actual investment. Very frequently when a rate question is up, the city council will appoint a committee or perhaps even employ an accountant to investigate the books. Usually w’hen the report is submitted, the city council will find itself as much in the dark as ever, or at the most, very little advanced. I do not by this mean to belittle a good accountant’s report, but I mean that the accountant’s report is only part of the information that is necessary. At this stage, the city council will usually find that what they need is an engineering inventory and appraisal, and this necessity applies to the company as well as the city.
We have found that when the city officials find that they have an actual inventory of the actual property used and useful in the production of the utility service, they feel that they are getting nearer to the actual value on which they should pay a return, than in any other way. With the inventory, they have before them an itemized statement of every piece of equipment, all of the buildings, of the poles, wire, pipe and all the other things which go to make the complete property.
On What Basis Should Items Be Priced?
With the inventory completed, the question, of course, arises, on what basis should the items be priced? Should it be pre-war, present prices, or an average covering a period of five or ten years? Many companies, especially during the period of abnormally high prices, favored a valuation made on the basis of these high prices. They were sustained in this by the decisions of many courts. The average citizen, looking at it from his standpoint, naturally resented this. He could not understand why he should be made to pay a rate which would give the utility a return on a value which was far in excess of the actual cost of construction, or even the average cost during a comparatively normal period. What the average citizen overlooked and what I believe was usually the company’s chief incentive in trying to get a high value, was the fact that probably for a considerable period, the company was operating on a rate that was too low. It takes a considerable period of time for a utility to obtain even a temporary increased rate, while during certain periods of the past few years, operating costs increased tremendously almost over night. This meant that if a utility was receiving a fair rate before the increase in operating costs, they sustained greatly reduced profits, and in many cases, actual losses before any relief was had. It was to recoup these losses that most companies asked for the returns on the higher valuation, but the average citizen could not understand this. I believe that the utilities really made an error in insisting on these high valuations. Many courts and commissions have ruled that the high prices must be given consideration, and I believe that a ten-year average covering the period of high prices and a period of more nearly normal prices gives a value which is fair to the company, and which appeals to the average man as much more reasonable. This also gives a more stable valuation. Of course, at the time of the peak of prices, the average value was much lower, but today on some items a ten-year average price is higher than the present price.
Overhead Costs and Going Value
Probably most difficult of understanding by the average citizen are items of overhead costs and going value. He can see that there is a certain value in an engine, but he does not at first comprehend why there should be added to this value an additional cost for engineering, taxes, interest during construction, etc. This can usually be best explained by showing how the physical value of the engine itself includes such items as engineering, taxes and interest at the factory where it was built, and these expenses must be met just the same in assembling a complete utility plant on the ground as in assembling an engine or other piece of equipment at the factory.
As to going value, the difficult thing for the average man to understand is, why there should be any extra value to a utility when it is losing money or barely paying expenses. He must be shown that the business has been developed and therefore, the value is there, and if there are no profits it is because the utility is not receiving a rate sufficient to pay a fair return.
In conclusion, I will only say that I believe that in most instances, if the company will show a desire to lay its cards on the table and treat the municipality fairly and squarely, it will receive the same treatment in return.
(Excerpts from paper read before the Oklahoma Utilities Association).