Benchmarking of electricity networks: Practical problems with its use for regulation

Benchmarking is a technique derived for management purposes, intended to identify outliers in any population as possible problems for resolution. Several regulatory agencies have tried to use benchmarking to define the degree of inefficiency of regulated companies, by reference to some target or frontier. This paper identifies the main problem inherent in trying to adapt a management technique to a regulatory purpose – namely that it requires the exercise of subjective judgements. The resulting lack of predictability and objectivity is not conducive to the provision of efficient regulatory incentives.This paper explains where subjective judgement enters into regulatory applications of benchmarking, which is not always apparent. The choice of model and selection of data sets are two obvious areas, but the main problem arises over the assumption that any costs not explained by the model must be due to inefficiency. Such assumptions are simply unsupported by evidence and lead to cost targets (or cost reduction targets defined over several years) that are little better than subjective guesses. There are other, superior ways to set cost reduction targets, based on long-term trends in total factor productivity for the regulated sector, which are used in the US and in other countries. However, some regulators feel obliged to use benchmarking and the paper concludes with recommendations as to how benchmarking should support further and more objective investigations into the costs of regulated utilities.