Management Challenges for the 21st Century
Chapter 7: The Challenges of Utility Pricing and Rate Setting
In market-based economies, prices charged for most goods and services generally are a reﬂection of supply and demand. When supply exceeds demand, prices fall. When demand exceeds supply, scarcity appears and prices rise. This is referred to as the general model of pricing. The model does not work in exactly this way when pricing the products and services of public utilities. External forces in the form of government regulations and political considerations often intervene in the price-setting process. Furthermore, federally mandated restructuring of the utility industry has introduced a new complexity into the practice of setting prices at all levels of the utility industry. The fundamentals of rate setting, price-setting practices, and such special pricing considerations as social pricing are discussed in the following paragraphs. Throughout the chapter the terms prices and rates are used synonymously, although in the industry, prices are sometimes (but not always) used to describe the wholesale cost of a utility product, with rates used to mean the retail price of the product. Managers in most businesses approach the price-setting process from two interrelated positions. The ﬁrst begins with the revenue requirements of the organization: income must meet the ﬁrm’s needs for each. These include cash for debt service, operating costs, providing an appropriate return to investors, and more. The second begins at the opposite end of the chain: determining what speciﬁc combination of prices, rate structures, and rate schedules will bring in the revenue required. This model is more complicated when the organization...
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