The first element of efficiency is an efficient level of OPEX. One of the most powerful instruments to control cost levels are benchmarking techniques, and in particularly, the efficient frontier technique.
The efficient frontier will show the efficient level of costs, at a given output level (or the efficient level of output, at a given input level). This frontier can be built endogenously, through the observation of cost and output levels of a group of comparable firms, or exogenously, from the design of a model company, usually built from engineering concepts.
The possible efficiency gains of a firm can be broken down into two factors: technological changes and catch-up. The effect of a technological change affects all firms and results from the introduction of technological improvements that move the output frontier. The catch-up component is the reduction of the distance separating a certain firm from the actual efficient frontier.
Depending on the sector, the stress will be placed in procuring that the operator's performance gets closer to the efficient frontier (catch-up), as it is the case in the water and sanitation sector - where the technology for the provision of the service is, in general, stable- or that the operator adapts to the technological change, evidenced by the constant changes of the efficient frontier, as it is the case in the telecom sector.
The results of these techniques can be used in tariff reviews to calculate the efficiency factor X to be passed through to tariffs, so the user shares with the operator the efficiency gains that the latter achieves, or to encourage the improvement of the firms' performance through the disclosure of the results, since in same cases, there is the possibility that these results influence the consumer's decision when choosing a service provider, such as in the United Kingdom. In any case, the exercise consists in evaluating the present cost levels and encouraging the firms to reach efficient levels, whether through the imposition of new cost objectives or as a consequence of the competition generated by the publication of the results.
Table 10 : Benchmarking Regulatory Applications
| Country | Technique, Input and Output119 | Regulatory Method | Objective |
| Great Britain | COLS (OPEX analysis), DEA and TFP. Input: OPEX Output: Compound variable (50% # of customers, 25% energy supplied, 25% network length) | Price cap | Benchmarking has been adopted as an explicit part of the process to determine the required revenue. It is one of the elements involved in the determination of the X factor in the tariff formula RPI-X. To promote competition and keep users informed. |
| The Netherlands | DEA: Total Controllable Costs. Input: OPEX Output: units, HV demand peaks, LV demand peaks, network length, small and large customers. | Yardstick competition | Adopted as an explicit part of the process to determine the required revenue. |
| Norway | DEA: Total Controllable Cost Input: Capital (book value and replacement cost), goods/services, losses, work. Output: # of customers, energy supplied, lines and wires length. | Revenue-cap | Benchmarking has been adopted as an explicit part of the process to determine the required revenue. |
| Finland | DEA Input: operational cost Output: number of customers, Energy supplied and customers' annual interruption time. | Expenditure-cap and Rate of Return | Benchmarking studies have been used to support rather than determine regulatory decisions. Benchmarking is used to estimate the reasonable rate of return. The rate of return is estimated on the basis of the costs of an average or efficient firm and not on the basis of a certain firm's costs. |
| Sweden | DEA, Performance assessment model (engineering analysis) Input: operational cost Output: number of customers LV, number of customers MV, energy supplied LV, energy supplied MV and maximum power. | Special case of Yardstick competition | Benchmarking is used to estimate the reasonable rate of return. The rate of return is estimated on the basis of the costs of an average or efficient firm and not on the basis of a certain firm's costs. |
| Australia-New South Wales | DEA, SFA, TFP Input: O&M costs, transformation capacity, network length. Output: Power sold, # of customers, peak demand. | Revenue-cap until 2004, weighted average price cap from 2004 | Benchmarking techniques have been used to examine the different aspects of the efficiency of electric power transmission companies. Benchmarking is only used as an additional instrument in regulatory decisions. |
| Chile | Theoretical model of an ideal company. Input: CAPEX, O&M, losses, and costs related to customers (LV, MV and HV) Output: Transmission value added (VAD) of the efficient firm. | Special case of yardstick competition. | Tariff reviews to evaluate costs, goals, and set new tariffs. |
| Colombia | The efficient management, O&M costs of electric power transmission are determine through the DEA methodology. | Price cap | Explicit use in the setting of tariffs to calculate X factor. |
Source: Mehdi Farsi, Aurelio Fetz, Massimo Filippini (2005, 2007); Kjell Sand and Dag Eirik Nordgard (2004); Cambridge Economics Policy Associates (2003), and own elaboration. TFP: Total Factors Productivity. DEA: Data Envelopment Analysis. COLS: Corrected Ordinary Least Square. SFA: Stochastic Frontier Analysis.
Furthermore, when setting the efficiency factor X, benchmarking practices also reflect the consistency principle, since the decision on the goal of the costs to be reached is generally determined through the participation of the firms in the sector.120 The regulatory agency shall require each firm to improve its performance in accordance with its relative position in the analysis. Therefore, the regulator will be fair with those firms that have made big efforts to improve their performance and will demand a greater effort for the following period from those firms which have not made such efforts. However, the goals to be imposed on the latter by the regulatory agency should be plausible and achievable, so treatment towards them is also fair.
This is the instance where certain controversies usually arise, since it is very unlikely that the firm will accept, without discussion, the cost adjustment decided by the agency. Therefore, such procedures are usually carried out by means of consultation documents and/or public hearings, so as to create the opportunity for the firm to express its opinion, and to make decisions on the determination of future goals available to the public, thus promoting transparency and participation in the regulatory process.
Benchmarking is also useful in terms of the relationship with other stakeholders as it provides technical support to de regulators decisions reducing controversy and opposition to tariff adjustments. By comparing the relative performance of various firm the regulator con justify disallowing excessive costs to inefficient firms. But also it serves to support decisions of giving efficient firms which are doing above average in terms of service incentives in the form of more revenues.
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119 For a review of benchmarking techniques, we suggest checking the bibliography cited in this sense in the Annex of Annotated Bibliography.
120 It can also be determined on the basis of the participation of firms from other countries or sectors. However, the use of comparable firms respects the consistency principle.