Electricity network companies operating in deregulated markets must remain competitive and deliver shareholder value while providing customers with an acceptable quality of service at a fair price. However, customer service and performance can be seriously compromised by a singular focus on profitability and it is for this reason regulatory frameworks are often implemented.
Ensuring equity in a deregulated marketplace
The regulatory framework often takes the form of revenue limits set by state or national regulators, with the general incentive to maximise returns through the reduction of operating costs below forecast levels.
While cost reductions may result from improved efficiency, they could also be the product of a reduction in service quality. To maintain and even improve service quality, regulators often introduce ‘performance service standards’. In some jurisdictions including Australia, performance standards provide a financial incentive for companies whose service levels improve and a penalty when there is a decline in performance.
Different regulatory jurisdictions have established different performance incentive schemes; some rely on past performance as a benchmark for future service levels, whilst others use rolling averages or industry standards to establish target performance. However the targets are set, the primary goal of the schemes is the same - to provide a set of rewards and sanctions that link a percentage of the utility’s maximum allowable revenue to standards of service provided to their customers.
Sometimes the performance metrics used favour short-term financial results over long term visions. We should be cautious over their value unless sound principles are used, underpinned by a strategy to develop a service performance culture long-term.
Establishing service levels
Whilst the introduction of performance incentive schemes is welcome, there are some concerns. These concerns vary from the method used to establish target service levels and the limits at which rewards and penalties are capped to the impact on networks of increasing volumes of renewable and small scale generation.
In terms of the methods used to establish target service levels a key concern relates to small data sets relying on the most recent five year period to determine service target. The preferred practice of regulators in Australia for example is to apply statistical analysis that assumes a normal distribution or “bell-shaped curve” to the five data points to analyse each performance measure.
Small data sets may distort outcomes
A key problem with small data sets is that they are prone to distortion; the result is that one or two annual performance results may benefit from unusual environmental or operating conditions. For example, outage rates for an electricity distribution utility will likely be much lower during periods of unusually lower storm activity compared with a typical storm season.
Another factor that must be taken into account when setting performance standards is the impact of fundamental changes to the structure and operation of the network – in particular the impact of intermittent renewable generation and small scale generation. With increasing emphasis on emissions and renewable targets the volume of small scale, often intermittent generation is increasing. Performance standards based on relatively small data sets or historical data may fail to adequately account for the impact of the challenge posed by such elementary network changes. Going forward network companies must be sufficiently incentivised to take into account the impact of such generation on their performance standards – possibly by entering direct contracts with the generators and more actively managing their networks.
Simple statistical analysis based on assumed probability distributions which do not take such operational and environmental considerations into account may potentially generate performance targets, maximum and minimum limits that are not appropriate, or in extreme cases, not achievable. Performance levels are reduced to an annual score or rating without meaningful interpretation as to what it all means for the customer. Whilst it is generally agreed by regulators and participants that such problems exist when small data sets are used, there is a growing tendency on the part of regulators to use this simple statistical approach without consideration of any operational context apparently for consistency in the decision making process across the electricity utilities.
The era of the passive network operator may be coming to an end and performance incentives must be designed to adapt to changing market circumstances. This is producing unwanted consequences. Performance incentives for electricity utilities must be realistic and provide a true incentive to improve. Targets which fail to consider operating conditions, and as a result are unachievable or impractical, can lead utilities to consider any performance incentive scheme more as an arrangement which might provide a convenient bonus to the bottom line at the end of the year, but not something to be monitored or driven. This is certainly not in the best interest of the customer, who has a realistic expectation that the utility will make best efforts throughout the year to look at ways of improving the quality and reliability of service, be it through maintenance works or operating procedures. The customer was originally, and must remain, the focus for performance incentive schemes, and the service levels provided by utilities should aim to be consistently good, and not above some arbitrary benchmark figure only at the end of the year.
Statistical approaches impede improvement
Recent regulatory decisions in Australia have sought to adopt a common statistical approach. In one instance, suggested maximum levels for performance could only potentially be achieved by the utility if the level of maintenance that had been historically applied was significantly curtailed. Such suggestions run counter-productive to the overall objective of a performance incentive scheme which should be to drive overall improvement.
Driving a performance based service-culture
In conclusion regulators should be prepared to understand the operating context for performance results and make adjustments as appropriate.
As competition increases and customer loyalty declines the winners will be those companies who are responsive to the needs, short and long term, of their customers.
Electricity companies should consider strategies to embed customer service improvements into the organisation and continue to evolve as customer-centric driven businesses - excellence in customer service will deliver a strong competitive advantage.
For further information on performance based regulations and ratemaking
© Sinclair Knight Merz
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Who does this affect?
Utilities and statutory entities with a vested interest in the performance and service delivery of network companies.
What do I need to do?
Consider the risks to network utility service performance standards based on small data sets that promote a short-term approach to service improvement.
Author: Jeff Butler
Jeff Butler, Strategic Consultant - Utilities, SKM, based in Brisbane, Australia.
© Sinclair Knight Merz
Requests to re-publish achieve articles should be made here