The third form1 of incentive regulation provides competition between comparable operators in separate markets. When using this form of regulation, regulators generally should choose performance measures that are general in nature and that operators can affect. An example of a general performance measure might be cost per kilowatt hour and an example of a more granular performance measure might be line maintenance cost per kilowatt hour. General performance measures allow operators to make economic tradeoffs – for example, between capital investments and operating expenses – while granular performance measures restrict the means by which operators can improve measured performance. In addition to being used for regulating overall price levels, benchmarking can be used for regulating such items as service quality and network expansion.
- Principles of Using Efficiency Measures in the reference section on Price Level Regulation covers benchmarking and yardstick regulation. Some analysts consider benchmarking or yardstick analysis to be an input into rate of return regulation, price cap regulation, or revenue cap regulation rather than as method of incentive regulation that could be used by itself. It is true that with benchmark or yardstick regulation prices are generally capped, which arguably makes the system look very much like price cap regulation. Here it is treated as a separate form of incentive regulation because some regulators treat it that way, but the authors recognize that benchmark or yardstick analyses are generally used as an element of a hybrid regulation scheme.