PBR's Changing Face
William D. Steinmeier ("Price-Based Regulation: The Elegance of Simplicity," Jan. 15, 1996, p. 35) presents an unconvincing and misleading case for performance-based regulation (PBR). He is right that PBR is potentially simpler to implement than cost-of-service regulation and provides a strong incentive for companies to cut costs. However, one of his main points (em that profits don't matter, only prices do (em applies only to competitive markets. Instead, the most plausible application of PBR lies with noncompetitive monopoly markets, such as transmission and distribution. (Remember, competitive markets should need no regulation!) In that setting, without limits on profits, companies may reap unconscionably high rewards from their captive customers.
This result (em a windfall from captive customers (em appears to be what has happened in Great Britain, which instituted an incentive-type regulation scheme when its electricity industry was privatized in 1990. The National Grid Co. earned a 1994-95 pretax profit of $959 million on a gross revenue of $2.242 billion (em a return of 43 percent. In the same year, the 12 distribution companies of England and Wales jointly earned a pretax profit of only 13 percent (even so, nearly double the profit margin of five years before). Most observers expect the companies to become even more profitable in the future. Concerned by this outcome, the U.K. regulator has begun to pay close attention to the costs and profits of these companies. PBR is beginning to look like American-style, cost-of-service regulation.