This document summarizes a study on economies of scale and utilization in the Swiss electric power distribution industry. It finds that economies of scale exist for small, medium, and large utilities in Switzerland based on an analysis of cost structures. However, the results regarding over-capitalization are inconclusive due to limitations in calculating capital stock. The study analyzed cost data from 39 distribution utilities and estimated variable cost functions to test for economies of scale and utilization.

1. Economies of Scale and
Utilization in the Swiss Electric
Power Distribution Industry
Author: Massimo Filippini
Presenters:
Arvind K. Yadav
Rashi Saxena

2. Electric Utility Industry
• Local monopolies
• Cyclical demand
• Require spare capacity for peak periods
– Too high?
– Over-capitalization?
• Swiss electricity distribution industry
– Economies of scale empirically evident

3. Cost Structure
• Convention: long-run cost functions
• Implication:
– static equilibrium
– Optimal utilization of inputs
• Contention: Absence of static equilibrium
w.r.t. stock of capital (quasi-fixed)
• Implication: Economies of scale based on
LR cost function may be imprecise

4. Suboptimal capacity:
Supporting arguments
• Costly adjustment to time profile of electricity
demand
– Longevity of transformers and distribution lines
– Long-term load forecasts and distribution
planning (inaccurate)
• Legal obligation to maintain excess capacity
– Service guarantee
– Exclusivity of territorial franchise

5. Variable Cost Function
• To model production structure
• Takes account of sub optimality
• Physical capital can’t be adjusted to
minimize TC during observation period
Production function …
y= F(x1,x2,…, xg; k1,k2,…ke; q1,q2,…qn; T) ❶
– Y: output; x: inputs; k: quasi fixed inputs;
q: operating and o/p characteristics variable;
T: vector of time shifts

6. Variable Cost Function
Properties Inputs
• Concave and linearly • Labor
homogenous in i/p prices • Purchased power
• Non-decreasing in input • Quasi fixed input capital
prices
• Decreasing in quasi fixed
inputs
VC function of a Swiss electricity distribution utility
VC = VC (y, wp, wl, k, T, LF, FDj) ❷
-y: output (kWh); wp, wl : kWh i/p and labor prices
-K: stock of capital; T: time; LF: load factor; FD: firm specific variables

7. Translog function
Sl = βl + µu ln (wl/wp) + ωyl ln y + πlk ln k +
ᵟ ln LF ❸
lLF
• Tested for
– Homotheticity
– Cobb-Douglas technology

8. Data/Structure
• Swiss electric power industry
• 1200 firms (public/private)
– 900: municipals
– 300: urban/regional
• Generation/Transmission/Distribution: small amount of
power generated
• 10 main utilities vertically integrated
– Generation/Transmission/Distribution: backbone
• 74%: distribution utilities

9. Caveats and Procedure
• Publically owned
• Data available: 60 utilities
• Utilities with more than 20% of their capital
invested in generating activities (21 nos.):
excluded
39 distribution utilities serving cities were
analyzed
• Measures of capital stock:
– Capacity measure
– Cost measure (data N.A.)

10. Results
• Four models:
– Model 1: Estimates of VC function model
specified in ❸
– Model 2: homotheicity assumed
– Model 3: corresponding to Cobb-Douglas
technology
– Model 4: ignores firm-specific effects, biased
• Statistically significant coefficients
• Cost elasticity < 1

11. Results
Expected Estimated
• VC function should be • Labor cost share is
increasing w.r.t. output positive; increasing in
and input prices input prices
• Concave w.r.t. input • Concavity is satisfied
prices • Increase in capital cost
with increase in capacity;
• Non-increasing VC w.r.t. non-increasing VC w.r.t.
capital stock capital stock not satisfied
• Cobb-Douglas and
identical fixed-effects
hypothesis: rejected

12. LR Results
• Marginally increasing in capital stock
increases (not decreases, as expected in
cost theory) VC
• Interpretations
– Positive sign of coeff. of capital stock indicates
excessive amount of capital stock employed by
firms
– Incorrect sign of coeff. of capital stock comes
from multicollinearity between output and capital
stock
• More precise as based on empirical analysis
• Causes unexplained

13. LR Results
• Cause of positive sign of coeff. of capital
stock: empirical difficulty in
defining/calculating capital stock variable
• Lack of data  SR cost studies use physical
measures  reflect max. available
production capacity  highly correlated with
increasing output  multicollinearity
• Solution: calculate capital stock using capital
inventory method
Estimation results are inconclusive to LR
cost minimization hypothesis

14. Economies of utilization and scale
• According to results:
– Utilization and scale economies exist
– If S/M/L companies increase output with holding
capacity fixed, VC increases less than
proportionally
– Increase in output without holding capacity fixed
increases TC less than proportionally
– Importance of utilization and scale economies
increases with size
Empirical results confirm economies of scale in
Swiss electric distribution utilities

15. Conclusions
• Economies of scale exist for S/M/L utilities
• Inconclusive regarding over-capitalization
• Policy implications:
– Utilities should operate as local franchised
monopolies
– Redesign on economic incentives to promote
optimal behavior
– Encourage competition and merger policy

16. THANK YOU