Performance incentives – How can regulators encourage improvements in specific dimensions of performance?

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[Response by Sophie Trémolet and Diane Binder, November 2010]

Regulators can encourage improvements in specific dimensions of performance with the following tools:

  • Setting performance standards [1] and implementing sanctions[2] in the case they are not met. According to Bakovic et al. (2003), “quality of service standards should be established for those dimensions of service that are important to consumers, controllable by the licensee and capable of being measured on a reasonably objective basis”. Standards can include for example payment of a fine for failing to respond to a query about charges within 5 working days (as done, among other countries, in the UK and Argentina). Focusing on a small but well-defined set of performance indicators, which can be adequately tracked and for which sanctions can be applied if needed, is often more effective than tracking a higher number of indicators – hence the need for identifying what customers really value.
  • Publishing information to name and shame sub-standard operators . The regulator can collect and publish data on the company’s overall performance against a range of indicators. In the UK, it includes the speed of customers’ reconnection after faults, delays before new customers are connected, the proportion of meter read (rather than estimated), etc. This allows the regulator to monitor trends in quality and to expose a company to public criticism if standards fall.
  • Linking service levels to prices , i.e. incorporating a direct link between the company’s allowable revenue and its quality of service in the price control formula. In the UK, Ofwat initiated a consultative process in 2001 to set out proposals to revise the measures used in the overall performance assessment of water companies and link service levels to prices. It was decided to reward companies providing the best service with an increase in price limits. Conversely, customers of companies providing a worse service receive bills which are slightly reduced by a negative adjustment to price limits. Companies will know in advance what financial impacts they will face for any given level of service.

Incentives alone are not sufficient to encourage the operators to surpass the minimum quality standards set by the regulator. They should be associated with penalties[3] to effectively encourage improvements.

Footnotes

  1. Refer to FAQ question: “What are reasonable efficiency targets?”
  2. Refer to FAQ question: “What penalties are most effective when the operator is in non-compliance with regulatory rules?”
  3. See BoK Chapter 6 Section B and FAQ question on “Penalties for non-compliance”.