Principles of Using Efficiency Measures for Yardstick Regulation

1. Performance measures for benchmarking, including efficiency, theft, and loss
2. Techniques for measuring efficiency and their properties, including frontier analysis, regression analysis, and virtual company approach
3. Issues in estimating benchmarks, including controlling for exchange rates and data quality and needs
4. Incorporation of efficiency parameters into price control formulas
5. Publication of benchmarking information

Core References

Understanding Regulation: Theory, Strategy, and Practice
New York: Oxford University Press, 1999, Chapter 18.
Baldwin, Robert, and Martin Cave

Outlines how to assess operator efficiency using benchmarking and yardsticking. Provides examples from the U.K.

Background to Work on Assessing Efficiency for the 2005 Distribution Price Control Review: Scoping Study Final Report for Ofgem
Cambridge Economic Policy Associates, September 2003.
CEPA

Examines approaches for analyzing benchmarking data. Considers regression analysis, data envelope analysis, and corrected ordinary least squares, stochastic frontier analysis. Examines scale variables, cost drivers, the benchmark variable, and quality.

A Primer on Efficiency Measurement for Utilities and Transport Regulators
Washington, D.C.: World Bank Group, 2003.
Coelli, Tim, Antonio Estache, Sergio Perelman, and Lourdes Trujillo

Describes the tools used for measuring efficiency. Considers total factor productivity measures, frontier analysis, and data concerns. Describes how these measures are incorporated into X-factors.

Performance Measurement and Regulation of Network Utilities
Northhampton, MA: Elgar, 2007.
Coelli, Tim, and Denis Lawrence (ed.)

Describes the tools used for measuring efficiency. Considers total factor productivity measures, frontier analysis, and data concerns. Describes how these measures are incorporated into X-factors.

Comparison of Building Block and Index-based Approaches
paper prepared for the Utility Regulators Forum, Australian Competition and Consumer Commission, 2002.
Farrier Swier Consulting

Examines price cap and revenue cap regulation in Australia, focusing on efficiency incentives, risk, robustness, transparency, simplicity, administration, and cost and availability of information required. Considers various methods for benchmarking utilities, including total factor productivity and data envelopment analysis.

Utility Benchmarking
Viewpoint, Note No. 229. Washington, D.C.: World Bank Group, March 2001.
Kingdom, Bill, Vijay Jagannathan

Describes how some regulators routinely publish indicators of utility service performance in the local media and how this provides incentives for poorly performing operators to provide better services. Holds that this also shields regulators from political interference. Reviews requirements for effective benchmarking in the choice of indicators.

Sectoral References

ELECTRICITY

Technical Efficiency in Electricity Generation – The Impact of Smallness and Isolation of Island Economies
Working Paper 0232 (CM14), Department of Applied Economics, University of Cambridge, U.K.
Domah, Preetum

Conducts a comparative technical efficiency analysis of electricity generators in small island economies. Does not find significant differences between islands and non-islands electric utilities. Suggests that “benchmarking of small islands, using non-island generating utilities as comparators, is both feasible and desirable given the lack of historical generation data for most small islands.”

The Case for International Coordination of Electricity Regulation: Evidence from the Measurement of Efficiency in South America
World Bank Policy Research Working Paper 2907, Washington, D.C., October 2002.
Estache, Antonio, Martin A. Rossi, and Christian A. Ruzzier

States that monitoring performance of public and private monopolies in South America is difficult because operators control most of the needed information and do not provide it to regulators. Argues that Latin America’s electricity regulators should use benchmarking based on performance rankings using comparative efficiency measures. This approach has modest data requirements. Demonstrates how this could be done.

Regulation of Electricity Lines Businesses: Analysis of Lines Business Performance – 1996–2003
Report prepared for Commerce Commission, Wellington, New Zealand, 19 December 2003.
Meyrick Consulting

Examines use of benchmarking in establishing X-factor for electricity distribution company.

TELECOMMUNICATIONS

Designing Incentive Regulation for the Telecommunications Industry
Cambridge, MA: MIT Press, 1996, Chapter 5.
Sappington, David E.M., and Dennis L. Weisman

Examines how to structure and establish performance goals and incentives. Considers broad versus targeted benchmarks, determining the appropriate performance level, and four basic principles for performance incentives.

WATER

Regulating Infrastructure: Monopoly, Contracts, and Discretion
Cambridge, MA: Harvard University Press, 2003, Chapter 9.
Gómez-Ibáñez, José

Discusses price cap regulation for British water sector. Considers historical context, the design of the price capping system, privatization, the 1994 and 1999 price reviews, effects of weather, and appeals. Assesses strengths and weaknesses of the system.

Cities Awash: A Synthesis of the Country Cases
in Thirsting for Efficiency, edited by Mary M. Shirley. Washington, D.C.: The World Bank, 2002, pp.1-41.
Shirley, Mary M., and Claude Ménard

Discusses yardstick competition, monitoring, performance targets, assignment of risks and rewards, incentives in tariff policies, and the roles of regulatory, judicial, and political institutions.

Water Privatization and Regulation in England and Wales
Note no. 115 in Public Policy for the Private Sector Washington, D.C.: World Bank Group, May 1997.
Van den Berg, C.
Examines England and Wales water sector privatizations.

Discusses cost structures and how regulator uses yardstick regulation.

Other References

Sector Organization, Governance, and the Inefficiency of African Water Utilities
World Bank Policy Research Working Paper 2890, Washington, D.C., September 2002.
Estache, Antonio, and Eugene Kouassi

Using a benchmarking approach, analyzes the determinants of the efficiency levels of African water utilities.

Strategic Behavior under Regulation Benchmarking
Working Paper WP 0312, 2003, Department of Applied Economics, University of Cambridge, U.K.
Jamasb, Tooraj. Paul Nillesen, and Michael Pollitt

Examines how electricity distribution companies regulated by benchmarking can engage in strategic behavior to increase profits without improving efficiency.

Key Words

Price cap regulation, Incentive regulation, Productivity, RPI-X regulation, Benchmarking, Costs, Competition, Comparative competition, Yardstick Regulation

Case Studies

Statistical Profile and Performance Benchmarking of Water Supply Services in 32 Major Western Australia Towns 1999/2000
June 2001.
Office of Water Regulation, Perth, Australia