Service Quality In Regulated Network Industries

ABSTRACT**: Economic regulators provide incentives for good quality of service as well as constraints on the prices or revenue which can be charged by firms with monopoly power. Economic theory suggests that regulators should choose standards according to consumers' valuation and the marginal cost of quality improvements, and that firms respond by equalizing the marginal costs from not making improvements (i.e. the regulatory penalty plus any loss in revenue) with the marginal costs of improvement. This paper explores the evidence for such economically rational behaviour by both regulators and regulatees. We use a specially constructed data set on service quality targets and achievements across the main UK utility sectors; documentary evidence from regulators; and interviews with managers in companies subject to those regulators. We conclude that regulators are motivated by political as well as economic factors. And that companies may not respond primarily to the regulator's financial rewards or penalties for their quality targets, with a consequent danger that regulated consumers pay for marketing in unregulated markets; the resulting level of service quality may be ‘too high’ in the economic sense.