Paraguay's aguateros-small privatewater companies- form an important part of the water sector,serving about 9 percent of the total population (or about 17percent of those with piped water supply). But untilrecently they operated only in urban areas, where waterresources are abundant, and they could choose customers,based on their ability to pay the full costs of providingservice. A new Bank-funded initiative seeks to attractaguateros and construction firms active in the water sectorto un-served rural areas and small towns, by providing anoutput-based aid subsidy, awarded through competitivebidding. The initiative is the first attempt anywhere toapply this approach to rural and small-town water sectorinvestment. This Note reviews the early lessons.