When and why would the regulator choose not to regulate the price structure, leaving the task to the operating company?
[Response by Sophie Trémolet and Diane Binder, June 2009]
Regulation may be desirable to address i) a difference between the objectives of the government and the operator, ii) an asymmetry of information between the government and the operator and iii) the monopoly power of the operator. Regulation is aimed at improving the utilities sector performance and to do so would strive to protect consumers from profit-maximizing monopoly operators, and operators from politically-driven decisions from the government and from competition. For instance, social objectives of the government to reach out to high-cost and low-income rural areas would contradict economic objectives of the operator to attain financial viability1.
However, there are some cases when regulation is not necessary.
- Regulation may not be necessary when the government and the operator have similar objectives, for instance to offer service of a particular quality throughout the country at the lowest possible cost. As long as strategic objectives are aligned, regulation would be redundant with the operator’s own course of action.
- Regulation may not be necessary in a competitive environment, since competitive pressure diminishes the problems of market power. Multiple service providers would compete primarily on price, and would push these down to a level both acceptable to the operator (since price would at minimum equal marginal cost) and to the consumers who will maximize their satisfaction of value for price. Competition will also address the information asymmetry problem in revealing customer’s actual demand and the operator’s ability to be efficient2.
In such cases, whilst tariff levels or structures may not need to be regulated, regulators should make sure that service providers meet basic quality standards3 and appropriately disclose service information so that customers can make an informed choice. For instance, Ofcom, the telecommunications regulator in the UK stopped regulating retail prices as of 2006 as competition was deemed to be strong enough to be self-regulating.
In addition, regulators should keep monitoring service levels and outreach so as to ensure that service providers do not “cherry-pick” their customers, i.e. that they do not compete only for the most profitable ones and abandon the less profitable ones, namely the low-income consumers in peri-urban and rural areas.
In certain cases, regulators may wish to continue regulating the overall price levels (through applying a RPI-X formula for example4) but leave flexibility to the operators in setting the tariff structure within this overall price cap, as long as they abide by some general principles such as non-price discrimination and equity (which requires to be precisely defined). This allows leaving maximum flexibility to service providers within the overall cap for defining their commercial policies and adapting to competitive pressures.
Understanding Regulation: Theory, Strategy, and Practice
New York: Oxford University Press, 1999, Chapters 13 and 16.
Baldwin, Robert, and Martin Cave
Restructuring Public Utilities for Competition
Washington, D.C, 2001.
Competition in Electricity Markets
Washington, D.C.: International Energy Agency, 2001.
What the Transformation of Telecom Markets Means for Regulation
Note no. 121 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997.