High-end restaurants rarely make money on food. However inflated prices may seem, the food tab just barely covers fish flown in from Japan, waitstaff salaries, downtown rent, broken wine glasses, and stolen forks. The cocktail menu, on the other hand, offers up an ocean of intoxicating profits. The chef may be a creative genius, but as a business, fancy restaurants are essentially bars that attract a wealthy clientele by giving away meals at cost.
Of course, no one requires you to get that cocktail, so starving students (or entrepreneurs) with a taste for fine dining can find bargains by ordering strategically. Get the meal, skip the drink, and allow the businesspeople traveling on an expense account to subsidize your night out.
In high-end restaurants, big spenders subsidize thrifty diners. Electricity markets work the same way.
A similar principle is in play in electricity markets. Regulatory bodies set rates to guarantee utilities a certain profit across their entire customer base. But customers themselves vary wildly in their patterns of electricity use, so inevitably tariffs create winners and losers. The losers pay more, and in doing so they actively subsidize the winners’ energy use.
Consider an example. Tinytown Electric has 10 commercial customers, each of whom uses 1 million kWh per year. The utility needs to make $1 million per year to cover costs and satisfy investors, so the rate is set at $0.10/kWh.
This year, Savvy Inc. takes advantage of a new energy efficiency incentive program: the utility kicks in $100,000 for a project that reduces Savvy’s electricity use by 20%. The utility now raises its rates to cover both the lost revenue from reduced energy use and the cost of the efficiency incentive. The net effect? Savvy’s total energy bill drops by 10%, a benefit that accrues year after year. Everyone else’s energy costs rise by 12% to keep the utility’s balance sheet healthy. (Download a spreadsheet with sample calculations.)
Savvy Inc. is the clever diner who understands the rules of the game and gets a delicious dinner at low cost – and everyone else in Tinytown subsidizes Savvy’s meal.
Real-world electricity pricing is much more complex, but the competitive dynamic is real:
- Most buyers think of energy prices as static, when in fact buyers are competing in a zero-sum game. You are either winning…or you’re losing.
- If you’re not paying for your own energy efficiency improvements, you’re paying for your competitors’. This reality is baked into the rates.
- On the flip side, energy efficiency leaders are lining their pockets with their competitors’ money.
Understanding the competitive dynamics of electricity pricing can help raise the profile and priority of effective energy management in your organization. And with the money you save, you can even splurge on that bottle of wine with dinner.
Image: Pipeline and Valve via Shutterstock