An approach that is typically viewed as an alternative to traditional cost of service regulation is performance-based ratemaking (“PBR”), which shifts the balance of the ratemaking process away from one that investigates costs, to one that sets a partly pre-determined (formulaic) path for rate growth.
PBR is a regulatory approach that aims to provide incentives for regulated utilities to improve efficiency. PBR seeks to mimic competitive pressures in a natural monopoly environment, providing incentives for utilities to meet a given level of service at the lowest/most efficient cost. In so doing, PBR regulation strives to determine an “optimal price” for monopoly services. Rather than examining individual costs in detail, it allows utilities to make decisions regarding costs and inputs themselves to both:
maximize output relative to a given level of inputs; and
ensure the most efficient allocation of competing inputs.
The formulaic approach to determining rates under PBR removes the incentive for utilities to increase sales, and instead promotes prudent investment decisions and efficient operations.