E E²

Benchmarking

With An Application to Electricity Distribution

GAP Workshop
14 December 2005, Berlin

Astrid Cullmann , DIW Berlin

-1-
 Agenda

1. Overview - Benchmarking Methodologies

2. Application in the Electricity Sector

3. Transfer to the Airports

Literature

-2-
 Overview of Benchmarking Techniques

Benchmarking

Partial Multi-dimensional Approaches

Approaches
(one-
dimensional)

Frontier Approaches Average Approaches

Induced
Non-Parametric Parametric Parametric
Approach

Data Stochastic Modified Corrected Ordinaray Total Factor

Performance Envelopment Stochastic
DEA Frontier Ordinary Ordinary Least Squares Productivity
Indicators Analysis Analysis Least Squares Least Squares
(SDEA) (OLS) (TFP)
(DEA) (SFA) (MOLS) (COLS)

-3-
 Data Envelopment Analysis (DEA) – (I)

max u ,v (u´ yi / v´xi ),

u´ yi / v´xi  1, j  1, 2,...N
Y Efficiency Frontier
e.g. DEA CRS u, v  0
units
sold
C B A max  , ( ´, yi ),
v´xi  1
Efficiency Frontier ´ yi   ´xi  0, j  1, 2..., N
DEA VRS
 ,  0,

min ,  ,
0  yi  Y   0
X
e.g. labour, network size
 xi  X   0
0
-4-
 Data Envelopment Analysis (II)

Advantages:
- Identifies a set of peer firms (efficient firms with similar input and
output mixes) for each inefficient firm.
- Can easily handle multiple output.
- Does not assume a functional form for the frontier or a
distributional form for the inefficiency error term.

Drawbacks:
- May be influenced by noise.
- Traditional hypothesis tests are not possible.
- Requires large sample size for robust estimates, which may not
be available early on in the life of a regulator.
→ Sensitivity Analysis by Bootstrapping

-5-
 Stochastic Frontier Analysis (SFA) (I)

ln( yi )  xi   vi  ui
SFA Assumption about the residuals
- vi are random variables
PSFA = f2(Y) assumed to be iid, independent of the
Y
- ui usually assumed to be half normal
POLS = α+f1(Y) distributed (truncated)
B
accounting for technical inefficiency
E

Efficiency of firm ESFA = EF/BF

yi ln( xi   ui ) y
exp(ui )   TEi  
exp( xi  ) ln xi  y

E[ui | vi  ui ]

0 F X

-6-
 Stochastic Frontier Analysis (SFA) (I)

Specify production (or cost) function:

1) Cobb Douglas ln(Qi )   0  1 ln( K i )   2 ln( Li )  (Vi  U i )

ln(Qi )   0 ln( Ki )   2 ln( Li )   3 ln( Ki )2   4 ln( Li )2

2) Translog Functional Form
  5 ln( K i ) ln( Li )  (Vi  U i )

Shortcoming;
Can handle only one output:
→ Aggregation
→ Distance Functions
- The decomposition of the error term into noise and efficiency component
may be affected by the particular distributional forms specified.

-7-
 Agenda

1. Overview - Benchmarking Methodologies

2. Application in the Electricity Sector

2. Transfer to the Airports

Literatur

-8-
 Efficiency Analysis in the Electricity Distribution

1) Efficiency Analysis of German Local Distribution Utilities

2) Efficiency Analysis of East European Distribution Companies (Poland,
Hungary, Czech Republic, Slovakia) in Comparison to Germany

The Issue:

- Increased use of efficiency analysis in the regulation of network industries

- Reform of the electricity sector: Incentive based regulation

- EU Directive 2003/54/EC and German Energy Law (July 2005)

-9-
 Choice of Variables

Inputs Outputs
LABOR: number of employees UNITS SOLD (in MWh)
NETWORK LENGTH: approximation NUMBER OF CUSTOMERS
for capital input (factored: high-, (residential)
medium- and low-voltage lines;
INVERSE DENSITY INDEX: (supplied
5;1.6;1)
area in square kilometres per
inhabitants)

• Number of customers is determined by industry and households within the supply area
can be considered as a given date
• Demand of the end users is quite inelastic and must be satisfied

Output is fix, input has to be minimized

- 10 -
 Our Empirical Application

I) We analyze technical efficiency (no cost data is available, VDEW data 2001)
DEA is applied as main productivity analysis technique:
- Constant Returns to Scale (Variable Returns to Scale for verification)
- Input-orientated approach
Input distance function approach with SFA for verification

II) Specify a translog functional form, general unrestricted form

Truncated normal distribution for the technical inefficiency random
variables
Specification of Battese and Coelli, 1995
Maximum likelihood method to estimate the parameters (Frontier Version
2.1, Coelli)

- 11 -
 Selected Results

DEA, Model 2, CRS - German local

100% distribution:
Efficiency in %

80% - East German

60% Utilities more
40% efficient
20%
0%
1 19 37 55 73 91 109 127 145 163 181 199 217 235 253 271 289 307

utility number

DEA Mode l 4 - CRS all countrie s - East European

Poland (1-33), Slovak Rep. (34-36), Czech Rep. (37-43), Hungary (44-47), Germany (48-84)
regional
1,0 0
Distribution
te c h n ic a l e ffic ie n c y s c o r e s

0,9 0

0,8 0 - Poland features

Germany
0,7 0
C. R. by far the lowest
efficiency scores
0,6 0

0,5 0
Hungary
0,4 0 S.R
.
- Scale inefficient
0,3 0 Poland
0,2 0

0,10

0,0 0

Firm number

- 12 -
 Measurement of Scale Efficiency

Difference Results DEA, Model 2, VRS-CRS • Difference Model 2,

DEA: VRS – CRS
Efficiciency Change in

70%
60%
percent points

50% • Economies of Scale

40%
30% seem to be limited, “big
20% is not necessarily
10%
0%
beautiful”

151
166
181

241
256
271
286
301
31
46

76

106
121
136

196
211
226
16

61

91
1

utility number

• Evidence for
DEA Model 1 - Scale Efficiency East European countries
Poland (1-33), Slovak Rep. (34-36), Czech Rep. (37-43), Hungary (44-47)

1,00 economies of scale in

0,90
Poland (area of
s c ale effic ien c y s c ores

0,80

0,70 increasing returns to

0,60

0,50
scale)
• Slovakia: scale
0,40

0,30

0,20
inefficiency due to
decreasing returns to
0,10

0,00

scale
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 3 6 3 7 38 39 40 4 1 42 43 44 45 46 47

Firm number

- 13 -
 Agenda

1. Overview - Benchmarking Methodologies

2. Application in the Electricity Sector

3. Transfer to the Airports

Literatur

- 14 -
 Transfer to Airport Benchmarking

- Decide which methodologies to use:

Stochastic Frontier Analysis not widely used. Integrate SFA, at least for
verification and validation method

- Focus on technical efficiency or allocative efficiency?

- Dynamic analysis with panel data?

Special Issue → technical change
Panel Data Models

- Choose appropriate input and output factors

Difficult task → many activities, heterogeneous

- 15 -
 Literature
Aigner, Dennis J., Lovell Ashley C., Schmidt Peter, 1977. Formulation and Estimation of stochastic Frontier Production
Function Models. Journal of Econometrics 6/1, 21-37.
Christensen, L.R., Jorgensen, D.W. and Lau, L.J. 1971. Conjugate Duality and the Transcendental Logarithmic Production
Function. Econometrica 39, 225-256
Coelli, Tim, Prasada Rao, Dodla S., Battese, George E., 1998. An Introduction to Efficiency and Productivity Analysis.
Kluwer Academic Publishers, Bostron/Dordrecht/London,
Coelli, Tim, 1996. A Guide to Frontier Version 4.1: A Computer Program for Stochastic Frontier Production and Cost
Function Estimation. CEPA Working Paper 96/7, Department of Econometrics, University of New England, Armidale NSW
Australia.
Estache, Antonio, Rossi Martin A., Ruzzier Christian A., 2004. The Case for International Coordination of Electricity
Regulation: Evidence from the Measurement of Efficiency in South America. Journal of Regulatory Economics 25/3, 271-295.
EBRD, Transition Report 2004, London.
Filippini, Massimo, Hrovatin, Nevenka, Zoric, Jelena, 2004. Regulation of the Slovenian Electricity Distribution
Companies. Energy Policy 32, 335-344.
Jamasb, Tooraj, Pollitt, Michael, 2003. International Benchmarking and Yardstick Regulation: An Application to European
Electricity Distribution Utilities. Energy Policy 31, 1609-1622.
Kocenda, Evzen, Cabelka, Stepan, 1999. Liberalization in the Energy Sector in the CEE-Countries: Transition and Growth.
Osteuropa-Wirtschaft 44/1, 196-225.
Shephard, Ronald W., 1970. Theory of Cost and Production Functions. Princeton University Press, Princeton.
Frontier Economics, and Consentec (2003) Netzpreisaufsicht in der Praxis, Abschlussbericht für VIK und BDI, London.
Riechmann, C. (2000) Kostensenkungsbedarf bei Deutschen Stromverteilern, Wirtschaftswelt Energie, 55, 6-8.
Schiffer, H-W. (2002) Energiemarkt Deutschland, 8. Auflage, Köln, TÜV-Verlag GmbH.

- 16 -