OFGEM IIP: Analysis of Basis for Rewarding Service Performance
9 June 2000
By Graham Shuttleworth with Brian Williamson
Alternative approaches to providing financial incentives for service quality have been implemented or are under consideration around the world for regulated utilities. In the UK, the water regulator Ofwat implemented an approach where a reward or penalty of half a percent of revenues for individual depends on the performance of each company relative to other companies.
The UK electricity and gas regulator Ofgem has proposed an approach that would also base rewards for performance in relation to the number, duration, and response to interruptions in comparison with other businesses.
This NERA brief demonstrates that the incentive properties of an approach based on relative performance in delivering service quality are not consistent with customers' short- and long-term interests. Efficient service quality levels occur when the cost of additional service quality matches customers' willingness to pay; therefore, to achieve an efficient outcome individual companies should be rewarded based on their own service performance and according to customers' willingness to pay. The existing Ofwat approach, or the Ofgem proposal, would not provide incentives for efficient behavior. Furthermore, the approach does not represent the conditions in a competitive market as claimed. In a competitive market, companies are rewarded for delivering an appropriate level of service, not necessarily a higher level of service than their competitors.
