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The price cap index (PCI) determines a company’s maximum allowable price change based on three factors: exogenous, inflation, and productivity offset. It aims to balance customer protection and economic feasibility. PCI was first used in the UK in the 1980s.
The main factors that influence a company’s price cap are part of an equation known as the price cap index. This formula determines the best balance between three factors: inflation, expected savings from efficiency efforts versus comparable companies, and factors beyond the firm’s control. The price determined by this information is intended to protect the customer from overload, while making it economically feasible for the company providing the service to stay in business.
Commonly known as the PCI, the price cap index determines the maximum allowable price change based on the combination of three factors. Each factor in the equation has a corresponding letter. There is an exogenous factor (Z), an inflation factor (I) and a productivity offset (x). These combined elements provide a comprehensive view of the company’s services versus those of the economy as a whole and a comparable industry.
The exogenous factor refers to elements beyond the company’s control that may affect its ability to do business. This can include events such as an economic downturn or natural disasters. It could also be an unforeseen local or global event that the company could not have foreseen. This factor is one of the most variable of the three. Faced with an inevitable setback, the company will be allowed to raise prices, but how much depends on the nature of the problem.
The inflation factor is determined on the basis of current data on inflation in the economy. The primary basis for comparison is the average of rates charged by similar companies in the same market. It takes into account both the performance of an average company and the current value of the country’s currency. If it is above average, prices will fall; if it falls below the combined factors, prices will rise.
Productivity compensation measures a company’s ability to save money with initiatives to increase efficiency. It also measures the success of these efforts against those of similar companies in the market. Both ongoing efforts to make improvements and current results are typically considered. If efficiency is higher, the price of services must go down. The reverse should happen if it is lower.
Price cap regulation was first conceived in the UK in the 1980s. Stephen Littlechild, an economist at the UK Treasury, came up with the method for managing the prices of private utility companies. It was a departure from previous concepts where revenue was the basis for determining price.
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