The electricity industry spawned in 1882 in the financial district of New York City when Thomas Edison’s utility business first provided electricity to neighboring customers. The customers had to be located within a mile of the power plant because, as the transmission was in DC, the resistance in the wires made electricity unusable beyond a mile. At that time, the idea was that electric utility business would be distributed into small areas as it was difficult to transmit power. It was difficult to imagine that electric utility business would be anything like it is in the present day. However, the development of AC transmission lines in 1880s changed the face of the electric utility business. Electric utilities could now provide electricity to a large area as high voltage AC power could be transmitted up to twenty miles. Combination of AC transmission and more power dense steam turbine generators lead to rapid growth of electric utilities. As the utilities grew and the increasing demand for electricity could be met due to technological innovations, the utilities became richer. They began consolidating with other companies to keep growing without the risk of competition like the Standard Oil Trust in the oil industry. One such example in the electricity utility business was Chicago Edison Company later called Commonwealth Edison. Electric utility business was just like the railways or oil industry where few companies controlled the entire business.
One of the mechanisms to fight these monopolies and bring back free market for electric services was the franchise approach. In the franchise approach, government would provide franchise to a number of firms thinking that competition would force the utilities to provide better services at lower prices. However, the already rich utilities bribed the government officials and got majority of the franchises. The franchise approach did not work because of corruption. Other model to control the utilities was municipalization. The government agencies bought the utility companies and operated them so that they could provide electricity at a reasonable price. In 1907 city owned utilities provided thirty percent of electricity. But, critics said that corrupt government officials would be a threat to public wellbeing in case of municipalization just like they were in franchise approach and that city owned utilities would maintain low prices by following poor business practices and cutting investment in equipment. There were other ideas floating around about electric utilities. One of them was them was that companies which provide essential services to masses must be regulated to avoid exploitation of masses and, other was that these companies must be natural monopolies as it was more efficient for one company to provide these services. This gave rise to the mechanism called regulated monopolies for the electric utility sector. According to this mechanism, utilities are given monopolistic franchise to generate, transmit and distribute power in designated areas with an obligation to serve all the consumers, whoever sought power, at a reasonable rate. In return, the regulators regulate the activities of the utilities and electricity rates.
The regulated monopoly structure or the vertically integrated utility structure worked well during the early days and lasted for more than five decades. All the parties involved in the electricity sector, the customers and the utilities, benefited from this mechanism. All the customers got electricity at a reasonable rate which made the customers happy. The utilities were provided a non-competitive market which eliminates the risk of competition. Moreover, utilities also benefited from the rate of return regulation which assured them a certain rate for return on the capital investment. The bankers provided easy finance to the utilities as they were guaranteed a rate of return and hence, there was less risk associated with them. Easy finance made it possible for the utilities to expand their operations and serve all the customers who sought power. The regulators had legislative, judiciary, and executive qualities and powers to regulate the utilities.
However, during the later years utilities gained control through advertising and political influence. They carried out campaigns to portray utilities as public servants. The utilities hired professors, journalists and consultants to carry out their propaganda. The Fair-Trade Commission uncovered corruption and financial abuses in the utility industry. Few numbers of people controlled huge sums of profits via holding companies. Moreover, during these years the quality of regulation faded. The regulators were less concerned about the public good. The quality of people regulating the industry deteriorated. The regulators thought that the utilities must be given a stronger position so that they could perform their tasks better. All of the above reasons made utilities more powerful than the regulators. The regulators favored the utilities and fulfilled their demands without any opposition. The utilities followed the Grow and Build strategy. They started building power plants which were more efficient, provide power to customers who would increase the load factor of a plant and provide power to customers in the rural areas. This allowed the utilities to provide more power at a cheaper cost. They continued to build more plants and the prices of electricity kept falling.
The vertically integrated structure did work well in its early days when the regulation was stricter and utilities followed it. It provided low cost electricity to a large number of customers. But, in the later days when utilities gained power and the regulators became liberal, it all started to fall apart. As electricity had becoming a basic necessity, keeping the utility system simple with no private investors and stakeholders would make it better for the consumer. City owned utilities being one of the simplest mechanisms, would have worked just fine if they followed good business practices and invested in new technology, which is very unlikely. Having said that, the vertically integrated utility structure was both good, as it provided cheap electricity and bad, because the it became corrupt and capitalistic. It would have been better if the regulation was stronger and the regulators were well equipped.
Reference: Power Loss, Richard Hirsh, The MIT press, 1999