Chapter 9: Cost-of-Service, Incentive Regulation or the Free Market
Chapter 9 investigates the regulation of price-setting behaviour in Danish utility companies which have been granted the status of legal monopolies. Price regulation is widespread among utility companies, such as water supply, sewage treatment, waste disposal and heat supply. The companies in question are financed entirely by user fees which are expected to match the costs of the service provided. This means that within a number of years, revenues must be adjusted to cover the costs exactly eliminating any potential profits.
This cost-of-service principle does not incite efficiency. In fact, it may lead to increased costs and less innovation. Therefore, there is reason to consider whether some form of incentive regulation could be appropriate. Possible methods range from revenue and price caps to best practice and yardstick regulation.
The cost-of-service principle has been successfully abandoned in many utility sectors. However, experiences from the telecommunications and electricity markets demonstrate the difficulties involved in designing efficient incentive regulation. The indications are that complexity does not necessarily enhance the efficiency of incentive regulation – rather on the contrary. Therefore, incentive regulation should continually be revised in order to optimise the efficiency of the selected method of regulation.
For further information please contact: Niels Rytter, Head of Division (+45 72 26 80 97) or Søren Andersen (+45 72 26 80 61)