Defining the Organization of Municipal Solid Waste Management Based on Production Costs

Beccarello, Massimo; Di Foggia, Giacomo Article — Manuscript Version (Preprint) Defining the Organization of Municipal Solid Waste Management Based on Production Costs Urban Science Suggested Citation: Beccarello, Massimo; Di Foggia, Giacomo (2023) : Defining the Organization of Municipal Solid Waste Management Based on Production Costs, Urban Science, ISSN 2413-8851, MDPI, Basel, Vol. 7, Iss. 2, pp. 1-15, https://doi.org/10.3390/urbansci7020034 This Version is available at: https://hdl.handle.net/10419/301791 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Urban Science, 2023, 7(2), 34; https://doi.org/10.3390/urbansci7020034 Preprent: Defining the Organization of Municipal Solid Waste Management Based on Production Costs Massimo Beccarello and Giacomo Di Foggia Citable as Beccarello, M., & Di Foggia, G. (2023). Defining the Organization of Municipal Solid Waste Management Based on Production Costs. Urban Science, 7(2). https://doi.org/10.3390/urbansci7020034 Abstract: A long-lasting dilemma on the efficient provision of services of general economic interest has become increasingly important in the waste management industry: competition or monopoly in municipal solid waste management. Previous literature has primarily examined the economics of scale and scope to provide an adequate response. Here, we contribute by investigating subadditivity in municipal solid waste management service costs. Subadditivity is a critical concept used to justify imperfect competition, which encourages natural monopolies where one producer will function more effectively than more firms. To test the hypothesis that a subadditivity in costs in waste management exists, we design a simulation based on empirical data for Milan, Italy. We compared the total production cost of the incumbent firm with the alternative hypothesis built by dividing the city into four areas and assigning each area to a different hypothetical firm. The results suggest that the existence of subadditivity results in 6% lower production costs, primarily stemming from business synergies, lower transactional costs, and optimization of productive resources and facilities. The evidence justifies, ceteris paribus, that the provision by a single firm is preferable to multiple firms in the analysis case. Implications for policies are straightforward. The one-fit rule approach fails to set the best condition for policymakers to create a level playing field transparently and efficiently for industry operators to perform efficiently. Keywords: waste management; cost subadditivity; economies of scale; economies of scope; waste management chain; MSW 1. Introduction Municipal solid waste management has become a major multidisciplinary topic and has gained even more traction in environmental economics [1,2] due to its prominent role in the transition toward circular cities. No wonder interest in how to identify the most cost-effective organizational forms has increased backed by circular economy targets. Although it may appear linear, there are stages and coordination complexities that characterize it. A division into two consequential stages that differ technically and economically can be used to simplify understanding. First, at the waste collection stage, the separation of unsorted and sorted waste takes place. Second, the treatment and disposal stages are when recyclable waste is treated and residual waste is disposed of [3]. Concerning coordination complexities, one should note that waste management service contains a multitude of subservices, including waste collection, street sweeping, cleaning, on-demand, or residual waste disposal services; see Appendix A for a taxonomy of those considered in this paper. Preprint 2 of 16 The key question is: what is the most efficient industrial setting for this service? Economic theory suggests that competition is the first option, provided that certain conditions are met. A fair, competitive environment is also one of the main targets of European legislation on competition and public procurement; see, for example, the Directive 2014/24/EU on public procurement [4]. However, there may be exceptions to this principle, for example, in the case of benefits arising from the optimal scale of production in a particular industry. We investigate whether the services of a single firm are socially preferable to those of several firms. We test this idea empirically by focusing on the production efficiency of waste management, considering possible subadditivity in production costs in the city of Milan, Italy. The analysis is developed by comparing a business-as-usual model in which waste management is provided by a single firm with an alternative scenario in which the city is divided into four areas and four firms provide the service in each of these areas. We add to the literature on industrial production empirical evidence from a sector that is becoming increasingly important due to its relevance to the circular economy, particularly regarding the existence of subadditivity of costs. The rest of this article is organized as follows: we review the relevant literature on economies of scale, subadditivity of costs, and waste management efficiency in Section 2. After that, in Section 3, some detailed information regarding the theory of cost subadditivity is provided together with the rationale for our hypothesis building and the research design. Section 4 contains the main empirical evidence. Section 5 discusses the main considerations and implications arising from the results obtained. Conclusions follow. 2. Literature Review Given the convergence of various factors, such as public policies [5] and climate commitments, the need to provide public services in an economic and eco-efficient way is a focus in environmental economics [6,7]. Furthermore, the trend of the global economy is stressing industrial structures, especially in countries that depend on the import of raw materials. Several approaches have been used to investigate this sector. In this paper, we review some studies that have dealt with scale and scope dimensions since, to the best of our knowledge, additional studies are needed on subadditivity of costs—that is the purpose of this paper. Efficient production size and scope and the environmental impact of firms are important for policy and market organization [8], and the number of relevant studies on the cost of waste management has increased [9–13]. The approaches used to estimate costs of waste management are often based on the unit cost method, benchmarking techniques, and cost estimation models using, for example, cost and production function analysis [14,15] and data envelopment analysis and stochastic frontier analysis [16]. Previous literature provides many insights into different technologies, scale economies, market forms, industries, and countries [17,18]. Scholars have also tried to empirically assess the impact of different regulated business models on waste management efficiency by focusing on the size of the territorial areas and municipalities [19,20]. For example, a recent paper analyzes municipalities that, like other production units, should be large enough to minimize average costs [21]. This is consistent with the fact that a renewed interest in decentralization has affected local public governance around the world [22], as well as at metropolitan scales [23]. Such studies can assess whether the scale of activities can explain performance in waste management [24]. Other studies focus on the cost structures of waste management [10], the relation with exogenous factors such as population density [25], the need to develop strategies to achieve sustainability targets [26], compliance with environmental legislation and costs [27], and zero waste management [28]. Similar approaches have been developed for other local environmental services, such as water, where studies suggest substantial cost benefits from the joint production of treated quality water [29] and potential benefits of appropriate scale and scope economies considering vertical and horizontal configurations of Preprint 3 of 16 water industries [30]. The increasing pressure for cost efficiency has prompted governments to transfer some waste services to private firms [31], giving rise to the question of whether for-profit firms are compatible with outcomes that maximize social welfare [32]. Economic and political factors exert different impacts on waste management by private and public firms [33]. Private waste management operators are not necessarily better performers than public firms [34] because the profit maximization typical of private operators may clash with the social and environmental targets typical of public services. To this end, business models and waste management methods, such as the organization of collection services, have received limited attention [35], even if they have a significant impact [36]. Both controllable and noncontrollable factors can have a significant impact on costs [37]. Broadly speaking, a function is said to have subadditivity when the whole is less than the sum of two or more parts. This attribute is important in economies of scale when the combined operating costs of two enterprises are less than the sum of their individual operating costs [38]. Economies of scale take place when the average cost of production declines as production increases. Such a decline in average production cost can stem from, according to the sector, high fixed costs, lower input prices, or learning economies. What characterizes economies of scale is that such relations typically operate over a range of output rather than for all possible output levels [39]. When economies of scale pertain to the firm’s entire output rather than to a specific product, the cost savings resulting from making these products together include a variety of economies of scope. Concerning economies of scope, subadditivity of costs refers to a situation where the total cost of activities performed in combination is less than the total cost of activities performed separately due to synergies [40]. Indeed, multiple products show scope economies when the combined cost of producing them is lower when their production is organized jointly than when it is separate for each product or produced by more firms [41]. In a public service such as waste management that is made up of many services, it is reasonable to think that, based on economies of scale and scope, a logic of vertical integration is necessary, e.g., for transaction costs and information efficiencies. Economies of scale and scope also affect the public service delivery market structure debate. Specifically, fostering competition incentivizes operators to operate efficiently. However, competition in the market is not always the preferred configuration, as the production technology or the characteristics of the services produced can generate market failures. In some circumstances, existing production technology makes it more efficient to concentrate production on a single subject than a solution in which several firms carry it out. In such cases, the activity is configured as a natural monopoly. It is recognized that municipal waste services have typically been provided through natural or legal monopolies [15]. Indeed, services of general economic interest have general economic utility often subject to public service obligations. Market rules apply to firms responsible for managing such services as long as competition does not prevent them from accomplishing their tasks in the general interest, for example, in cases of imperfect competition [42]. Therefore, such services can be provided either by the state or by the private sector and by more firms that are part of public contracts or in a monopolistic manner. Subadditivity of costs is a critical concept frequently used to justify imperfect competition, which encourages natural monopolies even if its analysis is challenging due to information asymmetry [43]. We help fill this gap by providing a detailed analysis of the cost production structure by empirically testing our idea using a specific business scenario. 3. Materials and Methods Arguments for and against monopoly and competition in the provision of services embrace many perspectives [44,45]. Subadditivity assumes that the output level is produced at the lowest cost by a single firm [38]. Economies of scope and economics of scale are constrained types of subadditivity by comparing the costs of more firms that specialize Preprint 4 of 16 in producing different outputs to one that produces two goods at comparable output levels. Taking an example of firms that produce individually, the production cost equals the sum of the costs incurred by each firm to produce a quantity q of product or service x. Equation (1) formalizes this concept, where Q stands for the quantity and i corresponds to one of the n firms existing in the industry. Equation (1) indicates that the production cost of the total quantity Q is the sum of the costs incurred by each firm to produce the share of Q, i.e., Q/n produced by each. 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡={ 𝑐𝑚(𝑄𝑥); 𝑜𝑛𝑒 𝑓𝑖𝑟𝑚 ∑ 𝑐𝑖(𝑄𝑥 𝑛) 𝑛 𝑖=1 ; 𝑛 𝑓𝑖𝑟𝑚𝑠 (1) The hypothesis underlying the theory of subadditivity is resumed in Equation (2). 𝑐𝑚(𝑄𝑥)≤∑ 𝑐𝑖(𝑄𝑥 𝑛) 𝑛 𝑖=1 (2) Natural monopolies stand out because marginal costs are typically small once an investment is made and because average costs decrease with increased output; if only one firm operates in the market, production costs may be lower than if there are competitors. The standard average cost functions for one or more firms are shown in Figure 1. Subadditivity indicates that it is cheaper to produce the same production level when only firm one is producing. The existence of economies of scale is a sufficient but not required condition for monopolies to be sustainable. However, subadditivity is considered necessary even if there are insufficient conditions for a natural monopoly to be considered efficient. Figure 1. Average costs of one and multiple companies in a monopolistic market; Q = quantity of output; AC average cost. We empirically tested whether starting from data on costs and waste production, Equation (3) Ho is verified, i.e., if the service falls between 0 and Q2 in Figure 1. In such a case, the collection of waste is configured as a natural monopoly due to economies of scale and above all, economies of density, which lead us to believe that the service costs are lower if the service is carried out by a single firm rather than by several firms. Beyond a certain level of output, in the case of Figure Q2, more firms are able to operate more effectively. In network services such as municipal solid waste collection, economies of density take on central importance. To ascertain the existence of a market failure, it is necessary to verify the conditions that make the collection phase a natural monopoly that cannot be contested. Preprint 5 of 16 A contestable natural monopoly, although not optimal, allows for eliminating the monopoly rents and can reach the most efficient allocation compatible with the cost coverage constraint in the absence of regulation. This result implies that in markets characterized by few irreversible costs and without other barriers to entry, competition in the market can produce results close to second-best efficiency even in the presence of natural monopolies. Furthermore, situations of market failure occur when the goods and services produced are public goods, such as waste management, because the market does not easily allow optimal production, given the difficulty in preventing free-riding behaviors. Research Design Our research question consists of testing the subadditivity of costs in waste management production costs in Milan. To contextualize the analysis, Table 1 presents contextual data regarding waste production. Table 1. Background information regarding waste in the city of Milan. Year Inhabitants Sorted Waste Waste Generated Sorted Waste Sorted Waste per Capita Waste per Capita Tons Tons % kg/Inhabitant kg/Inhabitant 2020 1,397,715 381,660 608,413 62.7 273.1 435.3 2019 1,406,373 433,404 707,507 61.3 308.2 503.1 2018 1,395,980 407,318 692,228 58.8 291.8 495.9 Source: Italian National Environmental Protection Institute. The waste management incumbent runs the service both in the Municipality of Milan and in seventeen other towns in the Milan metropolitan area. Table 2 contextualizes the scope of the incumbent to carrying out the case study; indeed, the incumbent firms run the service in the Municipality of Milan and in seventeen other municipalities in the metropolitan area. Table 2. Scope of analysis. Variable Total Case Study Number of Municipalities 18 1 Population 1844 1400 Area km2 383 182 Workforce 3097 2444 Source: Own elaboration based on incumbent website. Starting from the technical and economic data concerning the municipal waste collection service in Milan, we reclassified the cost of waste management to test our hypothesis. The cost reconstruction path started from information made publicly available by the Municipality of Milan, and the procedure for determining the values attributed to the activities refers to the accounting and technical documentation: the financial statements of the incumbent waste management firm, the indicators referring to the use and cost of personnel, and the indicators relating to the use of capital goods derived based on the service monitoring activity, as well as by analyzing the service contract. Based on the above information, we estimated the costs classified as follows: collection, sweeping, other services, and on-demand. To verify the existence of subadditivity in the costs, starting from the accounting data, we estimated the overall costs, hypothesizing that four firms ran the service as in Figure 2. Therefore, the business-as-usual hypothesis foresees that the total quantity of the service that corresponds to the waste management service for the entire city of Milan was provided by a single operator, whereas the Preprint 6 of 16 alternative hypothesis foresees that each of the four firms provide a fraction of the service provided the total quantity is the same. Figure 2. Approach for the alternative scenario. City of Milan, Italy. Inhabitants 2020: ~1.4 million, (metropolitan ~2.9 million). Elevation: 130 m above sea level. Area: 181.76 km2. Subfigure; localization of the City of Milan Milan is divided into nine districts; we did not take into consideration a scenario with more than four firms, as the same organizational measures could not be guaranteed for each one. The hypothesis of mutual use of production inputs by different firms in the same operating area appears incompatible with adequate levels of effectiveness and efficiency. Given the characteristics of the service and the city of Milan, we simulated by assuming four firms corresponding to the four incumbent divisions. Geographically, in Figure 2 firm 1 runs the service in the northeast area of the city that is denoted as area 1, firm 2 runs the service in the southeast area, i.e., area 2, firm 3 runs the service in the southwest area that corresponds to area 3, and firm 4 runs the service in area 4 or the northwest side of the city. This is due to the inevitable duplication of costs deriving from fixed costs and investments necessary for the organization and provision of the service over reduced operating areas—the reduction of the functional area does not correspond to a proportional reduction in costs. Therefore, we assume that each firm independently carried out the service in the assigned areas. Table 3 provides information regarding the city of Milan and how it could be divided to allow multiple firms to run the waste management service. Table 3. Reclassification of the city of Milan according to our scenario. Administrative Units Area 1 Area 2 Area 3 Area 4 km2 Pop km2 Pop km2 Pop km2 Pop km2 Pop District 1 9.7 98,679 4.8 49,339 4.8 49,340 District 2 12.6 163,335 12.6 163,335 District 3 14.2 145,328 14.2 145,328 District 4 21 162,795 21 162,795 District 5 29.9 127,280 29.9 127,280 District 6 18.3 152,519 18.3 152,519 District 7 31.3 177,731 20.4 115,525 11 62,206 District 8 23.7 188,650 23.7 188,650 District 9 21.1 190,058 10.6 95,029 10.6 95,028 Areas 1, 2, 3, 4 * 37.4 403,692 55.7 339,413 43.5 317,384 45.2 345,884 Milan 181.8 1,406,373 Source: Elaboration based on data available online for the Municipality of Milan. * Our estimation. See Figure 3 for a map showing overlapping between municipalities and areas. Preprint 7 of 16 Figure 3 overlaps districts and business units that correspond to the areas used in the alternative hypothesis. Figure 3. Districts and the four areas. In red nine districts, in green four areas From Table 3, the population of the four identified areas ranges from 0.31 to 0.4 million inhabitants, whereas the areas range from approximately 37 km2 to slightly less than 56 km2, from which we can derive population densities from 6 to 10 thousand inhabitants per km2. We were able to divide the costs between the four firms considering the minimum organizational information for the performance of the service, inferable from the information in the documents used by the agency of the city of Milan. Appendix A summarizes the four types of services: collection, sweeping, other, and on-demand—more than fifty different subservices constitute the waste management service. We define our hypotheses as follows: 𝐻𝑦𝑝𝑜𝑡ℎ𝑒𝑠𝑒𝑠: { 𝐻0=𝑐𝑚(𝑄)≤∑ 𝑐𝑖(𝑄 4) 4 𝑖=1 𝐻1=𝑐𝑚(𝑄)>∑ 𝑐𝑖(𝑄 4) 4 𝑖=1 (3) Considering the hypothesis formalized in Equation (3), we developed our research question to verify Ho. In this paper, we focus on the production cost structure. 4. Results Based on the above assumptions, a reasonable approximation of the total industrial cost of the individual activities that make up the waste management service was reconstructed. It should be noted that the total cost includes both the activities of collection and waste treatment and disposal. Table 4 shows the distribution and total cost according to the simulation designed to test our hypothesis. Table 4. Business-as-usual and simulation. Costs and Resources Workforce Means Production Cost Business-as-usual: incumbent 2444 761 314,879,379 c(Q) Collection 999 248 157,821,729 Sweeping 1378 498 141,086,581 Other services 36 15 13,077,784 On-demand 31 0 2,893,285 Alternative hypothesis: firm 1/4 Preprint 8 of 16 𝑐𝑖(𝑄𝑖 𝑛) Collection 285 70 45,323,303 Sweeping 390 141 40,399,649 Other services 16 6 3,981,982 On-demand 17 0 1,328,732 𝑐𝑖(𝑄𝑖 𝑛) Alternative hypothesis: firm 2/4 Collection 260 66 41,894,035 Sweeping 348 128 36,385,046 Other services 16 6 3,352,230 On-demand 17 0 1,310,193 𝑐𝑖(𝑄𝑖 𝑛) Alternative hypothesis: firm 3/4 Collection 230 59 39,019,567 Sweeping 328 128 35,136,937 Other services 16 6 3,197,337 On-demand 17 0 1,306,381 𝑐𝑖(𝑄𝑖 𝑛) Alternative hypothesis: firm 4/4 Collection 239 61 38,432,266 Sweeping 343 118 34,649,655 Other services 16 6 5,249,366 On-demand 17 0 1,289,739 ∑ 𝑐𝑖(𝑄 4) 4 𝑖=1 Ttoal alternative hypothesis: Firms 1, 2, 3, 4 2555 795 332,256,419 Collection 1014 256 164,669,171 Sweeping 1409 515 146,571,287 Other services 64 24 15,780,915 On-demand 68 0 5,235,045 Note: reconstruction of costs to predict the total cost of service under the two hypotheses was possible by accessing information contained in the service contract between the Municipality of Milan and the incumbent, see Appendix B for parameters. For each service contained in the service contract, all the production inputs, including staff, were allocated to one of the four actual business units. Differences in costs primarily derived from the fact that both staff and other production inputs would duplicate by dividing the service. This consideration is often omitted in economies of scale studies although it is of prominence. Table 4 shows that the output level is produced at the lowest cost by a single firm providing imperfect competition, which encourages one producer since it probably functions more effectively than more firms. This can be examined by comparing workforce and production means. Regarding the workforce, our results suggest that a monopolist produced the same output as four firms, employing 4% fewer employees and requiring 9.5% fewer means of production. Figure 4 compares the total production cost of waste management following our research design hypothesis. 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