Conducting A Price Review

A price review consists of four basic procedures, namely: decide what to regulate, evaluate the existing price control scheme, choose how prices will be controlled going forward, and implement the new control.¹ The first of these steps applies primarily to telecommunications, where competition serves as an effective regulator in many instances. The section on Market Structure and Competition and Tariff Design focuses on how to assess the competitiveness of a market.

There are several approaches to completing the last three procedures. The general practice in the U.K. is a two-year process that begins with gathering and analyzing information on costs,² investment plans, and demand forecasts; forecasting revenue requirements;³ choosing whether to use price caps or revenue caps;⁴ projecting revenue and cash flows using different price control parameters; and making the announcement.⁵ Time is allowed at the end of the process to complete appeals⁶ before the old price control scheme expires. In the U.S., resetting the X-factor in price cap regulation has involved extensive productivity studies and other information gathering.⁷ Developing countries often use a combination of the U.K. and U.S. approaches, depending on institutional capabilities and available information.

Most price review processes include multiple opportunities for receiving stakeholder and informing stakeholders of decisions.⁸ For example, Ofwat in the U.K. has followed a procedure that receives stakeholder input in the planning stages, data gathering stages, modeling stage, data analysis stage, and conclusion stage. The regulator issues numerous preliminary conclusions, explains the reasons for those conclusions, and asks for comments.

With most forms of price control, the regulator fixes the time between price reviews. Typical time periods are four and five years. The length of time depends on the confidence the regulator has in his price control parameters, the stability of the economy and industry, and the desired power of the incentive scheme. Setting the duration of the price controls involves a trade-off between the efficiency incentives and the need to keep the overall price level in line with the overall cost level, but in general, high confidence, a stable economy, and high power indicate long times between price reviews. Low confidence, unstable economy, and low power imply short times. Agency and operator resources must also be considered. With other forms of price control, such as rate of return regulation as practiced by the states in the U.S., high or low earnings relative to the cost of capital trigger price reviews, which are called rate cases. The regulator generally relies on the operator or a consumer representative to raise the issue of whether earnings are out of line with the cost of capital. If that happens, then the regulator conducts a rate case.

Footnotes

1. See Principles. The references in Principles provide other ways of dividing the work of a price review into multiple steps.
2. See Financial Analysis for information on obtaining, managing, and using financial information.
3. See Demand Forecasting for information on demand forecasting.
4. See Principles for information on choosing the form of regulation.
5. See Stakeholder Relations for information on strategies for dealing with the press and communicating with the public.
6. See Development, Review, and Appeal of Regulatory Rules and Decisions for information on appeal processes of regulatory decisions.
7. See Price Regulation.
8. See Institutional Design Issues and Stakeholder Relations for approaches to involving stakeholders in regulatory processes.