EBF 483
Introduction to Electricity Markets

6.2.2 The R&D Problem With Electric Utilities

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The Averch Johnson effect has had another side effect on electric utilities: it made them very hesitant to innovate. Many companies whose business models depend on technological performance (think Google, or smartphone manufacturers) spend massive amounts of money on research and development. Even companies that are not so technology dependent spend a lot on R&D.

Pharmaceuticals and computer manufacturers, for example, might spend 10% of their total revenue on R&D efforts to create new products that consumers will buy. Hotels, on the other hand, naturally have no real reason to invest massive amounts in research and development (the basic model of a hotel works pretty well). And in fact, they don't, spending less than 1% of total revenues on R&D.

The electric utility industry, however, has been unusual in being a highly technological industry that spends virtually no money on R&D. Historically, less than one half of one percent of revenues for electric utilities has gone towards developing new technologies to improve the way that electricity is generated and transmitted.

While this seems preposterous, it is actually a natural result of regulation. Remember that for an investment to make it into the utility's rate base it must be approved as "prudent" by regulators. The regulator does not always have to decide that a given investment is prudent, and it can also decide in the middle of a project that money is not being spent prudently. A finding of "imprudence" by a regulator can shift billions of dollars in costs from ratepayers to shareholders. Thus, the risks of new technologies not working out are simply too high.