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Consolidation: Key to the Future?

Why integration may win out in the long run.

Fortnightly Magazine - August 2005

investment.

The service company was another feature of the holding company economy, rendering services of various kinds to the operating companies. This was touted as a major benefit in that it made skilled but expensive experts-otherwise not affordable-available to the operating companies.

So, financing and expertise were the major claims of the holding companies. But they early were criticized for inflating the value of their operating properties and overcharging for services, thereby increasing rates. Later, these massive aggregations of capital drew political fire as the "power trust"-unregulated wielders of economic and political power. But the critique did not become lethal until the stocks and bonds of holding companies, widely held by a public convinced they were "safe investments," lost all, or almost all, their value in the Great Depression. Hundreds of thousands of destitute investors, thinking themselves bilked and defrauded, demanded a death sentence for holding companies, and that is exactly what they got. Section 11 of PUHCA decreed the extinction of interstate holding companies unless they qualified for an exemption-the most important being the possibility of "integration" of the operating utilities so they could achieve the economies and efficiencies assumed to result from combined operations. The goal of the statute was an "integrated public-utility system" that was physically interconnected and might be operated as a singly interconnected and coordinated system confined in its operations to a single area or region. The integrated system was to be not so large as to impair the "advantages" of localized management, efficient operation, and effective regulation.

Integration seemed to require that the utilities involved be contiguous, but this requirement became more flexible as the years passed. Because in 1935 no thought was given to the possibility of competition, it was immaterial that combinations of contiguous utilities acquired market power, and that this arrangement appeared to undermine the possibility of competition. At the time, integration was thought to be the ideal condition of yielding efficiencies-and, as we shall see, it remains powerfully attractive. Since the era of the holding companies, of course, the achievement of efficiency through competition has become popular as the royal road to lower rates. But, as has been indicated, the concentration of the electric generation associated with integration is in principle inconsistent with conditions that favor competition in generation. This is not to say that the two concepts cannot be made to co-exist through such measures as divestiture of plants and cession of control of generators or transmission. But, in principle, competition seems to favor a fragmented industry with large numbers of independent players.

Turning to Disaggregation?

Aggregated ownership of scattered utilities was condemned under PUHCA. This involved concentration of capital (with the attendant evils of the "power trust") without the operating benefits of integration. The authors of PUHCA were not impressed with the purported advantages of holding companies in obtaining cheaper financing or in making expertise available to the member companies. In their view, service companies were more a device for overcharging, and the advantages of size were not acceptable unless there was enough concentration to achieve integrated operation.

Now these