Under a price cap or revenue cap approach, rather than adjusting prices each year on the basis of the latest available data on actual costs incurred by the utility, average price (in the former case) or the annual revenue requirement (in the latter) is adjusted throughout the regulatory period in accordance with a pre-specified formula. This formula incorporates several parameters understood to reflect the costs of providing utility service – the two most common parameters are an inflation factor (reflecting trends in the overall economic price level) and a so-called X factor (reflecting improvements over time in technology and efficiency). With this type of approach, expectations about efficiency improvements throughout the defined period are ‘built-in’ to a multi-year pricing/revenue trend.
