The Secret to Successful Utility Rate Cases: Happy Customers

It’s not a great time to be running a regulated utility.  A perfect storm of aging infrastructure, low interest rates, constantly-growing compliance requirements, and even Mother Nature, have conspired to crimp profitability nationwide.  For the fourth quarter of 2015, public utilities are projected to see a 2 percent decline in corporate earnings growth versus the same period last year, according to S&P Capital IQ.

That leaves the C-suite and boards of directors of utilities companies in the unenviable position of having to navigate the next several years of strategic capital expenditures and expansion plans against the headwinds weaker profit forecasts and increased demand on resources.  Increasingly, this confluence of variables will lead many senior leaders toward the realization that the key to survival will come in the form of customer satisfaction.

Though it may sound like a Catch 22, the idea of investing in improved customer satisfaction while struggling through declines in profitability is not as impossible as it sounds, given the unique business model of the regulated utility industry.  Unlike the traditional public company model, whereby a business generates profits and invests those profits in growth initiatives, public utilities often spend money first and then recoup it later if they can demonstrate trust and explain the need for expenditures to their public utilities commission.

This process, commonly referred to as a rate case, is akin to a political campaign by an incumbent candidate that is simultaneously courting the trust of its constituency and angling toward reelection.   Just like a political campaign, perception is everything.  When customers feel good about their utilities, rate cases are approved.  When they feel slighted, the outcome is much less certain.

We’ve been able to demonstrate this phenomenon by-the-numbers in a recent analysis conducted with our partners at SNL Energy entitled How Customer Satisfaction Drives Return on Equity for Regulated Utilities.  By studying a wide range of customer satisfaction and financial metrics across the electric utility industry, we found that higher levels of customer satisfaction one year prior to a rate case are associated with higher levels of return on equity for a regulated utility. 

More specifically, we found that utilities that ranked in the top quartile of J.D. Power customer satisfaction ratings routinely receive rate increases closer to their request and outperform utilities in the lower quartiles by about 3-4 percent in annual profits.

It’s not an easy set of variables for utilities management teams to juggle and the process isn’t for the faint of heart, but our data has consistently shown that an investment in customer satisfaction today will yield dividends in the form of higher rates and increased profitability tomorrow.  As the chart below demonstrates, every year since 2001, utilities with above-average satisfaction scores have realized the highest average approved rate increases and corresponding return on equity.

When measured in absolute dollar terms, utilities in the top quartile of customer satisfaction ratings received an approved rate increase that was an average of $34 million less than initially requested while those in the bottom quartile received an approved rate increase that was an average of $49 million below their original request.

Utilities with top-ranked satisfaction scores also receive their rate case approvals sooner than those with lower customer satisfactions cores.  On average, electric utilities at the lead of the pack on customer satisfaction receive regulatory approval in under 7 months, compared with more than 8 months for lower-ranked utilities.

About the author:

Andrew Heath is Senior Director of the Utilities & Infrastructure Practice at J.D. Power. His email is andrew.heath@jdpa.com.

 

 

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