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Optional Two-Part Tariffs: Toward More Effective Price Discounting

Fortnightly Magazine - July 1 1997

2) by A2 + A5. Moreover, this optional tariff will produce the smallest discount that will enable the utility to retain the customer.

Types of Optional Tariffs

Depending upon the situation, various types of optional tariffs can be designed for a particular customer class or market segment.

Optional tailored tariffs. The utility can offer these tariffs to large customers with competitive alternatives. The tariffs are designed to produce the maximum margin contribution, and therefore the minimum possible discount necessary to retain the customer. Separate tariffs are developed for each customer. The access charges and usage charges are selected to maximize margin contribution subject to the constraint that the optional tariff is preferred to the base tariff and to the competitive alternatives available to the customer. %n6%n

Optional self-selecting tariffs. The utility can offer this tariff to both core customers (customers that do not have competitive alternatives) and noncore customers (customers that have competitive alternatives). One or more optional tariffs are designed for customers in a particular market segment. These tariffs are not tailored to specific customers, but instead are available on a "self-selecting" basis to all customers in the group. Consequently, customers in a particular group can choose any of the tariffs offered to that group. The tariffs maximize margin subject to the constraint that the tariff designed for a particular customer is preferred to: (1) the base tariff, (2) the competitive alternatives available to the customer, and (3) the tariffs designed for other customers. Because of the additional constraint that the tariff designed for one customer must be preferred to tariffs designed for other customers, the margin collection with optional self-selecting tariffs will be less than that collected using optional tailored tariffs.

Automatic tariffs. Designed for customers that do not have competitive alternatives, these tariffs are similar to the optional tailored tariffs in that separate tariffs are developed for each customer. The tariffs have common usage charge(s) but separate access charges. %n7%n The access charge is computed by multiplying each customer's base usage by the difference between the usage charge for the standard tariff and the common usage charge for the optional automatic tariff. Computing the access charge this way produces the same revenue as would be collected under the standard tariff at the customer's base level of usage. Of course, the economic benefit to the customer and margin contribution under the optional automatic tariff will be greater than under the standard tariff if the reduction in usage charge stimulates consumption.

Table 1. Price Elasticity and Marginal Cost Estimates

Price Margin Cost

Period Elasticity (cents/kWh)

Peak 0.10 3.0

Shoulder-Peak 0.30 2.0

Off-Peak 0.30 2.0

Table 2. Margin Collection for Core And "At Risk" Customers

Customer Margin Recovery

Groups ($million/year)

"At Risk" 52.4

Core 101.0

Total 153.4

Table 3. Distribution of "At Risk" Customers By Market Segment

Load Factor Peak Demand (MW)

(percent) 10 £ MW 5 £ LF 0.7 £ LF 3 2

Total 6 4

Table 4. Comparison of the Average Cost of Utility Service With the Average Cost of Competitive Alternative (cents/kWh)

Price of

Average Load Utility Competitive