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Labor Costs and the Rate Case

Incentives, staffing, and benchmarking in a tight economy.

Fortnightly Magazine - March 2012

force is highly specialized and characterized by a scarcity of qualified personnel. Utilities compete with one another, regionally and even nationally, for employees to fill many positions. In the ratemaking context, evidence regarding total compensation costs—including over time and relative to other comparable companies—is critical. Regulators might also be interested in evidence regarding the utility’s salary structure and individual components of compensation. However, it’s critical to evaluate these measures relative to the appropriate benchmarks, which must be derived from comparable companies and not merely on the basis of geographic proximity.

Identifying an appropriate benchmark group—or panel of comparable companies—will allow regulators to focus on the regional or national labor market in which a particular utility competes. It also will provide a reliable context for evaluating both the level and format of utility compensation expenses. Companies should be aware that regulators might be tempted to interpret a benchmark as a bright line, so it might be important to discuss the statistical properties of the benchmark sample in any interpretation of results.

Two principal steps are involved in peer-group benchmarking.

Normalization: The evaluator should determine whether the cost or performance measures at issue can be directly compared across companies, or whether a common means of measurement must be established for presentation to regulators. In the case of employee compensation, these costs will vary based on a number of factors including customers served, geographic region, and degree of vertical integration. Therefore, aggregate measures of employee compensation expense must be normalized—that is, transformed into a common unit of measurement—before a meaningful comparison can be made between the subject company’s performance and the performance of companies in the benchmark group. For employee compensation costs, measures of output, including sales and customers, are the commonly used normalization measures. Another normalization factor is number of employees.

Panel construction: Once a common basis of comparison has been established, the evaluator needs to construct the panel of companies—a list of “comparables,” in real-estate parlance—against which financial or service-level performance can be compared. The selection criteria will depend on the objective of the exercise. For example, regulators might want to conduct a broad evaluation of a utility’s performance relative to the entire electric industry. That would require a benchmark group that includes as large a group of utilities as possible, screening for company characteristics that are relevant to the particular compensation measure at issue. As a general matter, the selection criteria for benchmark companies would be based, in part, on company characteristics that affect expense levels, such as degree of vertical integration and lines of business.

Since any given geographic area will likely have only one regulated electric utility and one regulated gas utility, companies must recruit for skilled workers regionally and nationally. Factoring in the previously mentioned labor challenges utilities face, regulators will need to benchmark salary ranges by job description; this lens should reflect the regional and national labor markets in which utilities compete for talent. The commonly used sources for such data include industry-specific and broad-based compensation surveys. To the extent that utilities have outsourced positions that