Price setting in regulated utilities and the potential application to the BBC

1. The determination of the BBC’s licence fee is the outcome of an opaque and non-transparent process, which contrasts dramatically with that which applies in the case of the regulated utilities.

2. In all the main privatisations from 1984 onwards, the utilities are variously required to carry out specified functions, defined in licences. An independent regulator is given the statutory duty to ensure that the functions can be financed, through the setting of prices. Most regulators were initially also given a primary duty to promote competition.

3. Independent regulation underpins the ability of the utilities to borrow to finance investment, rather than rely on current revenues to cover current capital investment as in the public sector and in the case of the BBC.

4. The chosen price setting formula in these privatisations has been RPI-X.

5. The distinctive feature of the formula is that it is set on a forward-looking ex ante basis, so that for a period – until the prices are reset – the utilities are price takers, and hence in theory profit maximisation is equivalent to cost minimisation. This is the main incentive mechanism in the original regulatory model.

6. This approach is deceptively simple, and over time...

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