Many regulators include an exogenous cost component, or Z-factor, in the price cap formula. This allows the regulated firm to adjust for changes in costs that are beyond its control.
By including a Z-factor in the price cap, regulators can allow changes in certain types of costs to flow directly through to the price cap index, without affecting the regulated firm’s incentives to control its costs. Thus changes in the firm’s prices (or at least in the price cap index) can more closely track changes in costs.
When establishing a Z-factor it is crucial that regulators treat only those events over which the firm has no control as exogenous. Some exogenous factors are easy to identify, for example changes in taxation or in regulatory rules. However, other exogenous factors changes are difficult to isolate.
As an example, the Canadian Radio-television and Telecommunications Commission adopted an exogenous component in its 2001 price cap plan. Adjustments were considered for events or initiatives that satisfied the following criteria:
- They are legislative, judicial or administrative actions which are beyond the control of the company,
- They are addressed specifically to the telecommunications industry, and
- They have a material impact on the Utility Segment of the company.
CONCLUSION
There are significant technological and competitive changes occurring in the telecommunications industry such as the advancement and rapid growth of wireless services, the rapid development of packet-based communications, (VoIP), the emergence of cable companies as strong competitors to traditional phone companies and the potential for convergence to obliterate remaining distinctions between fixed and wireless communications.
As a result, regulators have begun the process of evaluating whether current price regulations still remain necessary for traditional telecommunications carriers. While certain form of regulatory intervention will likely remain for the long run—such as numbering resources, interconnection oversight, spectrum allocation, etc—some regulators have already decided that traditional telecommunications firms no longer possess market power and accordingly these regulators have begun the process of deregulating telecommunications carriers.
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