Nobody wants to open a bill for utilities and think, why is this bill so high? Behind that final number lies a web of decisions, policies, and calculations that most customers will never see. Instead, for the analysts and regulators who dictate those prices, structuring a fair and effective rate is no easy task.
So, how do utilities decide who pays what? And how do they balance fairness, financial stability, and public good?
Here, we’re going to give you a peek behind that curtain based on insights from the Don’t Fear the Cost Study by Clark Kaml.
Why Do We Need Rate Design?
Utilities are unlike most businesses. They often operate as monopolies (there’s usually one power company or water provider per area), so rates aren’t set by competition, they’re set by regulation.
That means someone has to step in and make sure the prices are:
- Fair to customers
- Enough to keep the utility running
- Structured in a way that reflects actual usage and system costs
That’s where rate design comes in. It’s not just about covering costs, it’s about building a pricing model that reflects values like equity, efficiency, and reliability.
Step 1: Start with the Cost Study
Every good rate design starts with a solid cost study. This is where the utility breaks down how much it really costs to provide service, across equipment, labor, infrastructure, and more.
But it’s not just one big number. The utility needs to allocate those costs across customer classes (residential, commercial, industrial) based on how each group actually uses the system.
Here’s the catch: there are multiple ways to do that. Do you spread costs evenly? Charge heavier users more? Use historical averages or forward-looking projections? The answers vary, and so do the outcomes.
Step 2: Define the Pricing Goals
Once the utility knows what things cost, it’s time to decide what the pricing structure should actually accomplish.
Should it encourage conservation? Reward low-income users? Recover fixed infrastructure costs more predictably? The rate design has to reflect these policy priorities.
For example:
- A flat monthly charge might help recover fixed costs but discourage conservation.
- A tiered rate could encourage energy savings but hit high-usage households harder.
- A time-of-use rate can shift demand and reduce system stress, but requires customer education and technology.
No single structure fits all goals. That’s why rate design is as much art as it is science.
Step 3: Test It for Fairness
This is where things get tricky.
As Clark Kaml points out, cost studies and rate designs can produce very different results depending on the assumptions. One allocation method might show residential customers getting a subsidy, while another method says they’re paying their fair share.
That’s why it’s important to test your design against key questions:
- Does any group unfairly subsidize another?
- Are the prices sending the right signals to consumers?
- Are we protecting vulnerable customers while encouraging efficiency?
- Will this structure hold up under regulatory scrutiny?
And most importantly: Can we explain it clearly and defend it confidently?
The Human Side of Rate Design
Utility bills impact real people as they shape the budgets for each month, company expenditure, and even energy decisions for the future.
What may look clean and proper to the accounting department may instead seem unfair and convoluted to the average customer. That’s where communication comes into play. If a rate design cannot be described succinctly in a single sentence, it is perhaps best to reconsider.
Wrapping It Up
Fair and effective pricing structures are not created by a formula. They come from thorough analysis, clear objectives, and sincere evaluation. When well-designed to do so, they create opportunities for financial viability, regulatory compliance, and public trust.
If you are in the midst of a rate design or looking for assistance to review your existing structure, CDK Consulting will be there to assist. With decades of experience in cost studies and utility pricing, it is our mission to bring fairness to every line item.
