Thursday, June 23, 2005

Competitive Pricing Schemes


I was thinking ... we have a privatised but heavily regulated electricity industry here in Aus. There is a bit of kerfuffle at the moment with the government wanting to drop the electricity prices a little ($82 per year - on average, presumably) and the electricity companies don't want to. While this is hardly surprising, their argument seems pretty good - they need that money for infrastructure spending. They've improved their efficiency (hence the "windfall" profit) but now they want to reap what they have sown.

So how's this for a pricing scheme. Take the average price for electricity. Presumably, half the companies will be making a profit at this level, and half will be making a loss. Well, actually most people will be making some profit. But there will be some point offset from here where that's true. The precise formula isn't that important.

Let's say we can identify the price point at which 75% of electricity companies will be at break-even or better, and 25% will be worse off than break-even. We then regulate this number to be the most that any provider is allowed to charge for their services. As well as this, we give people tax breaks for engaging in R&D, including infrastructure extension.

So every company has to compete hard so as not to fall into the bottom 25%, everyone gets breaks for engaging in R&D which will hopefully work out to more efficient electricity delivery, lower costs and better reliability, and the guys at the top get to make a tidy profit for being so good at what they do.

Okay, maybe this is just a pipe-dream idea. The primary objection that occurs to me is that electricity supply is an oligopoly, so you can't divide things so neatly. Also, it kind of forces 25% of the players to run at a loss, which isn't too good. But those in the bottom 25% could offset their loss by engaging in infrastructure rollout and extra R&D.

Ultimately, all that is probably necessary is a full publishing of a range of fine-grained metrics. Natural competition, on proper information, will probably take care of the rest.

Just a ramble! :)



Anonymous Clive said...

It is very hard, and often self-defeating to "properly" regulate utilities. They have the spending power and motivation to escape many effects of regulation, by a myriad of methods, including confusopolies* whereby they make pricing so confusing that it is nearly impossible for a consumer to calculate which is the better provider.

Although interesting, your pricing model could easily be sidestepped in broad-based conglomorates who will associate costs from other divisions to the utility to bring down its apparent profit. This will force up the cost of power. There will be many other ways to do this.

The best thing is probably just the free market, with occasional convictions and severe fines for price collusion.

* courtesy Scott Adams. Where companies with essentially identical products offer free gifts, free periods, links to other products, lock-in periods, wierd interest rate setups, etc to avoid competing on price alone.

6/23/2005 05:57:00 PM  
Blogger MelbournePhilosopher said...

True. I think the metrics would be enough, and I generally support tax breaks for R&D expenditure across the board.

One-time mayor of New York, Rudolph Guiliani, achieved a massive reduction in crime, as well as a number of other successes, which he largely attributes to having good metrics. Being able to identify groups that are performing highly, it's possible to spread around the goodness. Underperformance needn't be a chronic problem. People naturally motivate when given goals they can understand, and competition that they can feel equal to.

Electricity "needs" to be regulated, because it's a natural oligopoly - possibly natural monopoly - as well as a basic necessity. The electricity companies are basically differentiated only through staff efficiency - fundamental technology is largely static, although there is a push for "green energy". As such, it sems to me that the government needs to force their hands to invest more heavily in R&D.

Of course, I also believe we need government-funded "Australian-source" research and software development to give our companies the research edge over foreign institutions.


6/24/2005 06:56:00 PM  

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