Pricing: Cost of Service Versus Value of Water

Virtually nothing could be better or more successful without water services. As we all know, a community's water services provide unrivaled value to our communities, our health, and our way of life. What price would we pay for these benefits?

You may have heard someone say something like, “Water is so important that it should be priced to reflect its value!” That seems like a sensible point since we know water is the world's most vital resource. But should it really be priced that way? Pure value-based pricing would turn water into a luxury good, and the price would zoom upward beyond what most could afford.

Of course, pricing water properly is paramount for numerous reasons—and if not value-based pricing, what is the right approach? AWWA backs the vision that the public is best provided with water from self-sustaining utility services by pricing water using cost-of-service rates. Cost-of-service rates follow a generally accepted methodology that identifies the differences in the cost of providing service to each customer class and then sets rates designed to recover those costs from the customers who are responsible for the costs.

Although I can think of extreme exceptions, in general it would be safe to say that cost-of-service rates will be lower than value-based rates. Still, full-cost pricing is not simple or a guarantee of low-cost pricing. AWWA's 2024 State of Water the Industry report indicates that approximately one in four utilities struggles to, at best, slightly cover the full cost of providing water service (see the accompanying table). This is concerning given the same report ranks financial sustainability as the fifth greatest challenge facing the water sector.

Looking forward, AWWA's Water 2050 program stresses the importance of establishing pricing models that cover all of the costs of water service. It also promotes rate-setting that embeds costs associated with climate impacts, utility resilience, an evolving workforce, and infrastructure needs. Further, the Water 2050 program envisions the need for utilities to optimize efficiencies through a circular water economy, strategic partnerships based on shared economic interests, and the cost-saving efficiencies of technology. These considerations will affect, up and down, the level of future water rates.

What does all of this mean? First, setting the price of water is not an easy job that's free of controversy. Second, value-based rates would introduce new and complex challenges that are not necessary in the grand scheme of providing sustainable water services. And third, the methodology used to set cost-of-service rates is the best option. It results in pricing that recovers costs from a utility's customers in proportion to the cost of serving those customers and, importantly, supports the long-term financial sustainability of the community's water services. The immediate challenge, however, is that 26% of utilities already struggle to cover their costs and consequently must play catch-up if they intend to be financially sustainable.