This section discusses key issues in implementing a price cap regime. The key features of a price cap regime are:
- The regulator controls the average price of a basket (or baskets) of services. The firm has the flexibility to set prices for individual services, provided that the average price for the basket does not exceed the cap. On an annual basis, the firm and the regulator assess price variations to ensure that they conform to the price cap,
- The price cap includes an efficiency factor, or “X-factor”. Usually, the efficiency factor requires real prices to reduce over time to reflect expected efficiency improvements for the regulated firm,
- The price cap formula may also include factors to account for other variables, such as service quality and exogenous changes in costs.
In implementing price caps, regulators need to weigh the desirability of increased pricing flexibility for the regulated firm against the need to protect customers and competitors.
Similarly, under a price cap scheme, the regulated firm may be able to implement anti-competitive pricing strategies, for example by cross-subsidizing more competitive services from less competitive services. This can be addressed by:
- Setting price floors for certain services below which the firm is not permitted to reduce prices, or
- Placing more competitive and less competitive services in separate baskets.