Where firms have dominant market positions, price control is often introduced. While this may be seen as protecting the firms from politically-imposed excessively low prices, it also theoretically serves to protect consumers from excessively high prices and the loss of output which flows from that. Implementation is challenging: price control needs to balance not only these two over-arching concerns, but also the issues of efficiency in service delivery as well as the quality and availability of infrastructure services for end-users. Importantly, the regulatory environment must provide the service operator with an opportunity to earn a reasonable return on their investment. This is particularly important so that efficient future investment is not compromised. Pricing and performance issues are critical for the success of most private participation. Private participation can encourage clearer specification of the services that will be provided, their costs, and efficient pricing. There are following three primary approaches to set the overall maximum price level: - Rate of return regulation adjusts overall price levels according to the firm’s costs including a return on and a return of the capital invested. The regulator reviews the operator’s overall cost base in response to any proposal that higher (or lower) prices are needed to cover their full costs. In theory, this approach provides the best match of prices to incurred costs but delivers weaker incentives for efficient operation and development;
- Price cap regulation, which is sometimes called RPI-X regulation, was developed in response to the observed weaknesses in traditional regulation. This approach allows the firm to change its price level and its structure of charges according to an index that typically comprises an inflation measure and a “productivity offset” (commonly called the X-factor). This ‘de-link’ costs and prices provides a stronger incentive to improve efficiency and reveals the true costs of providing services, short and long term;.
- Benchmarking regulation can assist price cap regulation in that a price level is assessed based on the operator’s relative performance to the others. This approach provides incentives for the operator’s increase efficiency as efficient operators would be rewarded with extra profits. However, because of comparison difficulties, it can be challenging for regulators to place heavy reliance on the technique in making actual decisions.
Recently, regulators have used a “virtual company approach” in which the regulator constructs a simulation model of the operator and estimate the cost level based on an efficient operator. This can be used as an input into setting the price cap. .With any approach, best practices indicate that while designing tariff, regulators should consider factors which are beyond operators’ control. Such factors include macroeconomic conditions, geography, demographics, and history. If this approach is likely to be used, it should be made clear to investors as they are considering entering the market. The World Bank provides advisory support to assist governments and regulators to establish credible regulatory systems for infrastructure service pricing that consistent with the Government’s policy objectives. |
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