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Market Share in Generation: The Impact of Retail Competition on Investor-Owned Utilities

Fortnightly Magazine - July 1 1998

investments for exclusive right to sell into a well-defined market;

Products offered by the incumbent and potential entrants are physically identical (branded drugs versus generic).

Production capacity is largely fungible, with considerable latitude about which facilities produce the product.

Product price is much more than its variable cost.

Manufacturing and distribution do not have to be integrated.

Apart from the protection afforded by law or regulation, the cost of market entry is small.

Cost of product failure is extremely high.

There is likely to be some demand-side resistance to new entrants, given the goodwill accumulated by the pioneer while the market was protected.

Scenario #3

Full Competition: Small Loss at

First, then Accelerating

Evidence following competitive entry in the drug market presents both strategic and empirical issues for electric utilities. Strategic implications vary over time. First, as expected, the loss of an exclusive franchise results in immediate competitive entry. Later, however, entrants must invest in brand promotion and offer customers significant price discounts to capture market share. Thus, as competitive entry continues during the first year or two following the loss of an exclusive franchise, the demand curve facing sellers gradually "kinks." Entrant's products tend to occupy the price-sensitive region of the kinked demand curve, while the pioneer drug occupies the price inelastic (insensitive) region of the curve.

Evidence regarding competitive entry in retail generation comes from a combination of experience from the drug industry and recent empirical evidence from electric industry restructuring. To illustrate this case, we used data from the Pennsylvania Public Utility Commission's final order in the PECO Energy restructuring proceeding. That order provides a basis for translating what happens to patented drugs into what is likely to happen to utility market shares.

In PECO's case, the commission ordered that retail customers be given "shopping credits," which exceeded PECO's estimated market-clearing price for competitive generation. But when combined with rates for T&D and competitive transition charges, the credit still met the rate cap. In this way, the potential price reduction seen by customers following the introduction of retail competition will reflect the difference between the market-clearing price (estimated at 2.8 cents) and the shopping credit. The larger the shopping credit, the larger the potential price difference the customer would see reflected in his electricity bill.

This estimated price difference between a hypothetical range for the shopping credit and the predicted market-clearing price was combined with the elasticity estimates from the drug industry to produce this paper's forecast of market share loss with the introduction of retail competition. The results appear in Table 2.

Recall that the design of this analysis suggests the estimates of lost market share are maximum losses. Under the conditions used to produce Table 2, the incumbent utility is assumed to charge the maximum rate (the formerly regulated rate or rate cap), while entrants are expected to charge a rate equal to the market-clearing price. Further, the incumbent utility is not expected to engage in any form of advertising.

The findings show that if a utility takes a passive stance and does not match entrant prices,