Utility Customer Satisfaction: A Faith-Based Initiative?

By John Egan

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What’s Love Got to Do with It?

Although some of the specifics change from year to year, analyzing several years of data from J.D. Powers and L.E.K. confirm that there is no consistent correlation between shareholder returns for utility holding companies and the customer satisfaction performance of their electric operating companies.

The explanation may be simple: Top-performing utility companies tend to be larger and have a more aggressive business strategy compared to companies with fourth-quartile shareholder returns. Holding companies listed in Table 1 tend to have big, unregulated businesses—power marketing and merchant power generation—which appeal to investors looking for higher returns. The prospect (in many cases, the reality) of higher returns from less-regulated businesses may lead investors to bid up the shares of those companies. Investors are willing to shoulder greater risks if they can receive higher returns.

Regulatory Risks and Debt-Service Costs

Conventional industry wisdom holds that higher customer satisfaction lowers regulatory risks. That could translate into higher credit ratings and lowered interest costs on debt. In 2005, Todd Shipman, a utilities analyst at Standard & Poor’s (S&P), created a scatter-plot diagram showing that utilities with higher customer satisfaction tended to experience lower regulatory risks. Similarly, utilities with lower customer satisfaction tended to experience higher regulatory risk.

S&P said it would include utility customer satisfaction performance as one of several qualitative factors to assess the credit-worthiness of utilities. Shipman emphasized that a utility customer-satisfaction performance was a swing factor, not a significant driver, in setting credit ratings for utility borrowers. To date, S&P has made no changes to utility credit ratings because of a utility’s customer satisfaction score, Shipman says.

Regulatory Outcomes

As regulated entities, the business prospects of many electric utilities often rise and fall on decisions by state public utilities commissions (PUCs). The most important of these regulatory encounters are rate cases—of which there have been and will be many—and strategic transactions such as mergers and acquisitions. Among the most controversial and most significant regulatory actions are decisions on new or upgraded generating capacity.

Regulatory orders on returns on equity (ROE) and strategic transactions result from the blending of “objective” quantitative analytics with “subjective” qualitative judgments of the regulators and their staffs. Despite a regulatory commission’s heavy reliance on quantitative metrics, there is no way to remove the qualitative factors like “just and reasonable,” “used and useful,” and “fair” from the regulatory process.

What does the data tell us about any correlation between customer satisfaction and awarded ROEs? Very little.

Table 3 shows no consistent pattern linking the customer satisfaction of shareholder-owned electric utilities with those utilities’ authorized ROE. The customer satisfaction data comes from J.D. Power while the awarded ROE data comes from the Edison Electric Institute’s annual rate case summary for 2008. All the regulatory decisions in Table 3 came during the 2008 calendar year. Typically, a utility files its application about one year prior to the PUC decision.

Table 3. No discernable pattern linking residential electric utility customer satisfaction and authorized ROE for utilities. There appears to be no clear or consistent relationship between residential electric customer satisfaction and authorized return on equity (ROE). This table combines investor-owned residential electric utility (IOU) customer satisfaction data from J.D. Power and Associates with data on authorized ROE for investor-owned electric utilities from Edison Electric Institute. There is a relatively narrow band of 75 basis points separating authorized ROEs for electric utilities with top-quartile customer satisfaction. But a far wider band of 190 basis points separated authorized ROE for electric IOUs with fourth-quartile customer satisfaction. Some utilities with fourth-quartile customer satisfaction performance actually had higher authorized ROE than utilities with first-quartile CSAT scores. Source: J.D. Power and Associates; EEI Annual Rate Case Summary, 2008

One manager for a utility with a long record of market research and top-tier customer satisfaction quantified benefits the following way: “Our state regulators have awarded us a higher rate of return, about 0.5%, equal to $5 million in incremental annual earnings, with higher customer satisfaction being the differentiator.”

As with Tables 1 and 2, the data in Table 3 raise as many questions as they answer. Why would several electric utilities with fourth-quartile customer satisfaction have meaningfully higher authorized returns than electric utilities with first- or second-quartile CSAT scores? In a world where a 25-basis-point difference (one-quarter of a percentage point) in ROE could mean $25 to $50 million a year in annual revenue, that is the proverbial $64 million question.

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