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 Some Features of Pate Flx5.ng 
 
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 George L, Hoxle 
 
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 Engineers and Architects Association 
 
 OF SOUTHERN CALIFORNIA 
 
 Some Features of 
 
 RATE FIXING 
 
 FOR ELECTRIC PUBLIC SERVICE PROPERTIES 
 
 By GEORGE L, HOXIE, Ph. D. 
 
 Member American Society Mechanical Engineers 
 Member American Institute Electrical Engineers 
 
 of Hoxie & Goodloe, New York and Los Angeles 
 
 Paper presented to Engineers and Architects Association 
 of Southern California 
 
 April 18, 1912
 
 3L9- 5 
 
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 2 
 
 ENGINEERS AND ARCHITECTS 
 ASSOCIATION 
 
 OF SOUTHERN CALIFORNIA 
 
 OFFICERS. 
 
 Homer Hamlin President 
 
 Jas. D. Scliuyler 1st Vice-President 
 
 A. B. Benton 2nd Vice-President 
 
 H. Z. Osborne, Jr Secretary-Treasurer 
 
 DIRECTORS. 
 
 John C. Austin 
 
 N. D. Darlington 
 
 R. H. Manaham 
 
 E. L. Mayberry 
 
 Some Features of Rate Fixing 
 
 For Electric Public Service Properties 
 
 By GEORGE L. HOXIE, Ph. D.* 
 
 Mem. A. S. JM. E. and A. I. E. E. 
 
 Rate-fixing is one of the newer engineering 
 problems. It is true tliat rate-fixing com- 
 missions have been, and are, largely 
 composed of lawyers, but the members of 
 all of these commissions h'ave found it 
 necessary to rely largely upon their engin- 
 eering experts, and it seems to the writer 
 entirely probable, as well as desirable, that 
 the engineering profession should in the 
 future have an increasing share in handling 
 rate-fixing matters. It seems probable that 
 ■ for some time to come there will be a stead- 
 ily increasing number of engineers either 
 employed directly by commissions, or em- 
 ployed by public service corporations in 
 connection with the work of commissions. 
 It is therefore important that engineers 
 should devote some attention to the prob- 
 letns of rate-fixing. 
 
 It is not the intention of the present paper 
 to present solutions of any of the various 
 questions that are continually arising in 
 rate-fixing, or even to enumerate all of the 
 important matters connected therewith, but 
 it is the author's aim to speak of some prob- 
 lems in a very general way, in the hope that 
 there may be a full discussion, leading also 
 to a preparation of other papers by other 
 authors, to the end that the engineering 
 profession may have the large influence that 
 it should have, upon the working out of the 
 principles that are to guide future rate-mak- 
 ing commissions, and may also guide the 
 courts that will pass upon their determina- 
 tion. The writer is not one of those who 
 
 *Of the firm of Hoxie & Goodloe, Engineers, 
 of N'^w York and Los Angeles. A paper to be 
 read at the April meeting of the Engineers and 
 Architects Association of Southern California 
 on April 18, 1912, at Hollenbeck Cafe. 
 
 believe that the first few court decisions, 
 covering a new field, should form precedents 
 binding the human race for all time. With- 
 out criticising any court or any decision, it 
 seems to the author that the whole subject 
 of the relation of public utility corporations 
 to the public is so unsettled that progress 
 will be made by each contributor stating 
 freely what he thinks ought to be, substan- 
 tially without regard to past court decisions, 
 or even to existing laws. The present paper 
 will be wholly confined to a discussion of 
 rate-fixing as applied to electric public ser- 
 vice properties. 
 
 Methods and rules for the appraisal of 
 property, and the principles governing deci- 
 sions on the revenue property is entitled 
 to earn, are not yet generally agreed upon. 
 The questions involved are quite new, both 
 to engineers and to lawyers, and perhaps 
 it may be said without disrespect that they 
 are also new to judges. It therefore hap- 
 pens that there have already been conflict- 
 ing court decisions, and probably there will 
 be in the future a good many more such deci- 
 sions and perhaps greater conflicts than 
 have yet become apparent. Eventually of 
 course there mtist come a general agreement 
 on questions that are now exceedingly con- 
 troversial. Such agreement can come only 
 after all of the matters about which there 
 are now differences of opinion have been 
 discussed so fully that the fallacies of the 
 wrong notions and the correctness of the 
 right notions (whatever they may be) be- 
 come at last apparent to all. The judges 
 who now decide things are perhaps in the 
 most difl[icult position of any of the parties 
 involved. A judge must decide on what is 
 brought before him and has little or no time 
 for digging out ideas of his own, or for the 
 
 or: 

 
 bringing out of points perhaps not in tlie 
 minds of the counsel on either side. Coun- 
 sel also are largely dependent ui)on their 
 engineers. Engineers therefore should not 
 permit their ideas to be too much circum- 
 scribed by early judgments but should bear 
 their part in the making of that public opin- 
 ion which when fully matured will event- 
 ually be expressed by law-makers and courts. 
 There has already been a considerable 
 amount of published discussion of various 
 features of rate-making, such as the proper 
 allowances lo be made for depreciation; 
 the correct methods of making appraisals 
 of physical property; what constitutes a 
 company's investment; going value, etc. No 
 particular originality is claimed for any of 
 the things herewith presented. 
 Principles 
 
 Rate-fixing is designed to accomplish three 
 objects. First, that the people served by a 
 public utility shall pay the lowest rate pos- 
 sible, consistent with efficient service and 
 a proper return on the investment of the 
 corporation. Second, that each class of con- 
 sumers pay its proper proportion of the 
 total revenues. Third, that there shall be 
 no discrimination between individual con- 
 sumers of any given class. 
 
 The third problem is not difficult. It is 
 only necessary to pass laws forbidding dis- 
 crimination and to see that those laws are 
 not evaded. There is no difference of opin- 
 ion as to the desirabrlity of preventing dis- 
 crimination, and there is little difference of 
 opinion as to what constitutes discrimina- 
 tion. 
 
 The other two problems are very difficult. 
 Taking up the first question, it must be de- 
 termined primarily what is a "proper re- 
 turn," and second, what constitutes "invest- 
 ment." We will consider to begin with the 
 case of a successful public utility. (It is 
 obvious that a utility that was not needed 
 by the people served, or one that is operated 
 at such cost that the people served cannot 
 afford to pay a proper return on the cost, 
 cannot be subjected to the same rules that 
 apply to a successful public utility.) The 
 consumers served by a successful corpora- 
 tion can afford to pay, and should pay, an- 
 nually a sum of money sufficient to cover: 
 
 (a) The usual rate of interest on safe 
 investments. 
 
 (b) An additional sum to compensate for 
 whatever special risk the business of 
 the public utility may involve; and 
 
 (c) Such excess profits as are necessary 
 to induce capital to engage in the bus- 
 iness. 
 
 Item (a), or the rate of interest on safe 
 investments, is to be such a rate as may 
 be paid by savings banks or yielded by high- 
 grade bonds, that is, a rate that would be 
 paid on money invested with practical safety 
 
 and where the capitalist is not calKd ujion 
 to exercise much personal supervision over 
 his investment after having once made it. 
 
 Item (b) will vary with the character of 
 the business, the character of the commun- 
 ity served, the length of time the utility 
 hag been established, the probability of 
 future competition, etc. Item (b) may be 
 as little as one per cent or it may be very 
 much more. For a settled utility, necessary 
 to the community served, well and econom- 
 ically managed, and not unpopular with the 
 general public, the special risks inherent 
 in the business are small, and are such as 
 would be included in the possibility of 
 strikes, either of workmen or of politicians, 
 the possibilities of new inventions making 
 parts of the plant obsolete, or change in the 
 attitude of the public leading to hardship, 
 or possible bad management or dishonesty 
 in the future, etc. It is hard to imagine 
 a public utility that must not face these and 
 similar possibilities and therefore insurance 
 should be provided against such possibili- 
 ties, such insurance to take the form of a 
 greater return than a savings bank or high- 
 grade bond would make. The amount al- 
 lowed must depend upon the judgment of 
 the rate-fixing body but must also be in line 
 with integrated judgment of investors, ex- 
 pressed by the prices of stocks in similar 
 pubjic utilities as compared with the dif- 
 ferent rates of return on such stocks. It 
 should be pointed out that the stability 
 given by proper public supervision, which 
 rate-fixing implies, (such supervision for ex- 
 ample as the state of Wisconsin and some 
 other states now give to their public utili- 
 ties) should, and in fact does, greatly dim- 
 inish the risks of the business and therefore 
 diminishes the rate that investors are will- 
 ing to accept on stocks, or, otherwise ex- 
 pressed, operates to make public service 
 securities more marketable. 
 
 Item (c), covering excess profits neces- 
 sary to induce capital to engage in the busi- 
 ness, is somewhat akin to item (b) and in 
 fact the two items might be combined, yet 
 there are some real differences and it has 
 therefore been thought proper to include the 
 third item, covering inducement. Capital is 
 usually induced to engage in a business by 
 a promoter. Item (c) may therefore be 
 thought of as represented in part by pro- 
 motion stock, or by the earnings of promo- 
 tion stock. Usually, however, at least in the 
 case of those few public service enterprises 
 that are initially of considerable size, the 
 inducement of the promoter's eloquence is 
 not suflScient. The capitalist will not enter 
 such an enterprise unless there is a real 
 money inducement (or a reasonable expec- 
 tation of such inducement) in excess of 
 ordinary interest plus proper payment for 
 risk. It must be remembered that the 
 actual risk run by the capitalist, as meas-
 
 ured up by a cold-blooded commission after 
 the enterprise has been successfully estab- 
 lished, and the apparent risk, as it first ap- 
 pears to the timid capitalist at a time when 
 the whole project exists only in the brain 
 of the promoter, are two very different 
 things. If then the enterprise be one that 
 the public needs, the public must be pre- 
 pared to pay an inducement. This induce- 
 ment may be in the form of a moderate 
 return on stock partly water, or larger re- 
 turn on net investment, but it must appear 
 to the capitalist to be reasonably certain or 
 he will not engage in the business. The 
 size of the necessary inducement must be 
 a matter for the judgment of the commis- 
 sion. Public policy demands that it be as 
 small as possible, but public policy also 
 demands that full faith be kept with the 
 capitalist in the matter of payment after 
 he is fully committed and is helpless. The 
 present tendency in some states is to cut 
 down "inducement" to the point where many 
 desirable enterprises cannot be financed. 
 If similar rules applied all over the world, 
 capital would be forced to accept them. As 
 it is capital is very nimble, and goes where 
 it can do best for itself. It follows that 
 stagnation sometimes comes to a commun- 
 ity as a result of actions taken with the 
 best possible motives, and perhaps perfectly 
 desirable and politic actions, could they only 
 apply the world over. 
 
 The promoter as well as the capitalist 
 must usually be paid. Where the enterprise 
 grows from a small beginning the promotion 
 charge is negligible. Where the enterprise 
 is born full size the promoter should be 
 allowed a reasonable percentage. The cost 
 of promotion is a real cost. It is impossible 
 to establish any large enterprise without 
 promotion. It is true that it is sometimes 
 possible to pay the promoter wholly in hope, 
 yet in the long run promoters must be paid 
 at least something in cash, or else public 
 enterprises will lag and useful projects will 
 fail of development. The value and neces- 
 sity of promotion is very frequently dis- 
 puted and probably the statement that the 
 cost of promotion is a legitimate cost will 
 provoke some criticism. The fact is how- 
 ever, that the stimulation of the promoter 
 is necessary and in fact indispensible, to 
 the organization of even the most useful 
 projects. Item (c) may be taken care of 
 either under the head of "What is Invest- 
 ment" or under the head we are now consid- 
 ering. In either case the final decision, 
 expressed in dollars of capitalization, or 
 expressed in present rate of return to be al- 
 lowed, is and must be for some time to 
 come, a matter for the judgment of a com- 
 mission. Some day, it may be a long way 
 in the future, or perhaps not far ahead, there 
 may be an agreement upon exact rules for 
 
 the determination of items (b) and (c). For 
 the present they must be fixed upon judg- 
 ment. 
 
 What Is Investment 
 
 Investment may be in money, or in services. 
 The latter is as real as the former. The 
 fact that services have frequently been 
 grossly over-valued has led to a feeling that 
 the investment of services should not be 
 permitted. This seems wrong. The services 
 of the promoter, for instance, may usually 
 best be paid in stock. This amounts to say- 
 ing that the services of the promoter may be 
 capitalized. The danger is of course that 
 stock being sometimes simply a matter of 
 the printing press, an excessive payment is 
 made for promotion, and the public is there- 
 after charged with the necessity of paying 
 dividends upon a large amount of water. 
 Promotion stock in fact is not water unless 
 it be issued to a greater amount than the 
 actual services of the promoter justify. 
 
 In some cases the cost of promotion is 
 paid by the consciousness of the promoter 
 that he has performed a public service for 
 the benefit of the community. This is not 
 so rare as may be imagined. A conspicuous 
 example is that of the Los Angeles aqueduct, 
 now nearing completion. In connection 
 with this enterprise a number oT public- 
 spirited gentlemen presented to the city the 
 product of their imagination in conceiving 
 the enterprise and of their labors in pro- 
 moting it, which latter in this instance con- 
 sisted of conducting a campaign that con- 
 vinced the voting public that taxpayers' 
 money should go into the proposition. By 
 the ordinary standard of private enterprise 
 the initiation and financing of such an enter- 
 prise would be considered well worth a very 
 large sum of money provided the enterprise 
 proved on completion to be financially suc- 
 cessful. In this case, and in not a few sim- 
 ilar cases, the promoters are in fact content 
 with having accomplished the work, and in 
 such public approbation as they may receive. 
 The city in this case, or the private enter- 
 prise in some other cases, is the gainer. 
 
 In appraising a public utility just put to- 
 gether and ready to operate, the writer 
 would include in the appraisal, besides fig- 
 ures representing the cost in place of each 
 physical item, (cost of engineering, cost of 
 insurance, etc.), also the exact cost of put- 
 ting together the corporation, (cost of legal 
 work, etc.), and besides these would include 
 payment for the energy and initiative used 
 on the scheme as a whole, under the head of 
 "Cost of Promotion." All the items on the 
 schedule added together would then be the 
 true "Investment" when the entire plant 
 stands ready to begin operation. 
 
 Investment is usually of two general 
 classes, represented by bonds and by stock. 
 It is the return made to stockholders that
 
 is nuiinlj' effected by rate regulation. It 
 is usual in cost discussions to consider the 
 entire investment as if it were furnished by 
 stockholders, which as a rule it is not. The 
 return to stockholders made up as hereto- 
 fore described as being savings bank inter- 
 est, i)lus compensation for risk, plus induce- 
 ment to engage in business, should only be 
 paid on that part of the investment that 
 carries risk with it, or in other words, 
 should only be allowed on that part of the 
 investment made by the stockholders. 
 
 It frequently ha])pens that 75 per cent or 
 more of the money required for a project 
 is furnished by bond holders. For illustra- 
 tion let us assume that in order to sell its 
 bonds an enterprise must i)ay a return of 
 5% per cent on money received from the 
 sale of bonds. This allows for some dis- 
 count and commission on the usual 5 per 
 cent bonds. If the proper return to stock- 
 holders on their part of the investment 
 (sum of items (a), (b) and (c),) be set 
 at 10 per cent, the average necessary return 
 on the total investment, 75 per cent of which 
 is rei)resented by bond money costing 5^^ 
 per cent, and 25 per cent of which is money 
 from stock which is to be allowed 10 per 
 cent, becomes 6.25 per cent. In making such 
 a division in any particular case the exact 
 financing of the utility under consideration 
 should not be used, as it is obviously un- 
 just to penalize a company for having a high 
 credit, and for being able to sell bonds bear- 
 in:^ a low rate of interest to the extent of 
 perhaps 80 or 90 per cent of the total cost 
 of say a particular extension. It is obvi- 
 ously equally unfair to reward a company 
 for having such poor credit that it may 
 perhaps only be able to raise a quarter of 
 its needed money from bonds and may be 
 obliged to get from its stockholders the 
 other three-quarters of the money needed. 
 A commission should consider the general 
 conditions under which similar public utility 
 companies of ordinarily good standing can 
 issue and sell bonds. The commission may 
 then adopt an average credit standard and 
 may reasonably permit a company that ex- 
 ceeds this standard to profit by so doing. It 
 must of course be considered that an enter- 
 prise just being established and presumably 
 not being able to raise a very large percent- 
 age of its money from bond issues, must 
 offer correspondingly good inducements to 
 stockholders, as their risk and the difficulty 
 of getting their money increased. 
 Franchise Value 
 
 In most rate-fixing investigations the 
 franchise itself is not permitted to be re- 
 garded as an investment on which earnings 
 are made. This is not necessarily the 
 case, however, as it frequently costs money 
 to get a franchise, and the terms of the 
 franchise frequently involve an annual ex- 
 pense to the company. For example it is 
 
 not uncommon for an electric lighting com- 
 l)any as a condition of its franchise to en- 
 gage to supi)ly electricity to various public 
 buildings free of charge, or the company 
 may as a condition of its franchise engage 
 to perform street lighting at an especially 
 low rate. Where any of these elements are 
 found the franchise represents either a real 
 legitimate initial expenditure, or a constant 
 annual exiienditure, and in either case the 
 franchise may reasonably be regarded as 
 capital on which revenues must be earned. 
 In the latter case the expenditures may 
 with equal justice be charged instead as 
 operating expenses, if for any reason this is 
 preferred as a matter of bookkeeping. 
 Going Value 
 
 Assuming that we have decided what con- 
 stitutes "investment" for an enterprise just 
 completed and ready to operate; what is 
 "investment" for "going concern?" It is 
 rather obvious that a completely equipped 
 utility company ready to operate, but having 
 no customers, has a different value from the 
 same utility a little later when we may as- 
 sume that its total product is being sold at 
 a remunerative figure. The difference in 
 value between a company without customers 
 and the same company under full operation 
 may reasonably be considered as repre- 
 sented by the cost of putting the company 
 into the latter condition; in other words, 
 the cost of establishing the business. This 
 sum is represented by early losses, or by 
 the failure to earn proper profits, in the early 
 years of operation. Some caution is neces- 
 sary in arriving at a figure for "going value" 
 on this basis and it cannot be contended 
 that an unsuccessful company, or a company 
 which was not needed by the community 
 when it was put into operation, or in other 
 words, where the enterprise could not reason- 
 ably have been expected to be a financial 
 success, should be permitted to capitalize 
 losses over a long series of years even 
 though such losses in fact occurred. It is 
 assumed in the discussion up to the present 
 point that we are dealing with successful, 
 or reasonably successful, utilities, and it 
 may be readily seen that except in very rare 
 instances even the most successful public 
 utility must spend time and money in creat- 
 ing business. Such expenditures are really 
 necessary costs, paid in money or its equiva- 
 lent, and worth money or its equivalent, 
 and therefore are legitimate items going to 
 make up "investment." 
 
 Depreciation 
 
 There is a wide difference of opinion as 
 to proper methods of figuring depreciation 
 and even as to what constitutes deprecia- 
 tion. As these matters have already been 
 considerably discussed before the various 
 technical bodies, it is not the intention of 
 the present paper to consider the matter of 
 depreciation in detail. It will therefore be
 
 assumed that depreciation is figured on a 
 straight line basis, using the assumed usel'ul 
 life of the various items making up the total 
 investment as a basis for determining the 
 yearly charge against each item to cover 
 depreciation. It is also assumed that depre- 
 ciation has only one value at a given mo- 
 ment for a given item. The items of cost 
 of franchise if any, and the costs of general 
 engineering, superintendence, insurance, 
 law, promotion, going value, etc., should be 
 subject to a depreciation charge as well as 
 are the items covering actual physical prop- 
 erty. This means, of course, that such in- 
 tangible costs as those just enumerated are 
 to be written off, or amortized, in the course 
 of time. Such costs are assumed to be in- 
 curred but once, and when fully paid back 
 from a depreciation fund it may logically 
 be assumed that they have been written off 
 and removed from the capital account. The 
 application of depreciation to intangible 
 items of this sort may be justified logically 
 on theoretical grounds but without entering 
 upon any theoretical discussion it will prob- 
 ably be generally conceded that as a prac- 
 tical matter it is advisable to amortize 
 intangible costs when, and as soon as, pos- 
 sible. 
 
 Supervision of Depreciation Fund 
 
 The rate-making body should have super- 
 vision over the accotmting and bookkeep- 
 ing, in connection with expenditures from 
 any fund collected for the purpose of balanc- 
 ing depreciation. A well-managed corpora- 
 tion should have the fullest power to decide 
 upon such expenditures, since the officers of 
 the corporation, if competent, will ordinarily 
 be in a better position to form correct judg- 
 ment of how money should be spent than 
 will any Supervising commission. The fund, 
 in the discretion of the corporation's officers, 
 should be permitted to be used for replacing 
 worn-out machinery or buildings, for buying 
 needed real estate for the future, for build- 
 ing entirely new plants, extending lines, or 
 in such other legitimate expenditures as the 
 officers in charge may deem most beneficial 
 to the corporation's present and future bus- 
 iness. The only restriction on such expen- 
 ditures should be merely such as will satisfy 
 the commission that wise judgment is being 
 exercised. 
 
 The bookkeeping in connection with de- 
 preciation expenditures should be wholly 
 under the control of the commission, that it 
 may be made certain that no part of the 
 plant, built with depreciation money, is 
 capitalized, even though the depreciation 
 fund proves in the course of several years, 
 to have been larger than was really neces- 
 sary. This, of course, applies to additions 
 made under regulation and not to additions 
 made out of surplus earnings before the 
 advent of rate regulation. 
 
 It has been suggested that a competent 
 commission would revise the depreciation 
 allowances from year to year, so as to keep 
 the fund in the long run at very closely 
 the exact equivalent of the depreciation that 
 has occurred. This is one of those things 
 that look easy, but in fact are practically 
 impossible to carry out. If the depreciation 
 allowed be too large to begin with, it is 
 likely to be too large continually, and if, as 
 the writer believes best, the fund may be 
 invested in new construction, it must be 
 under the general supervision of the rate- 
 making commission, or injustice to the pub- 
 lic is likely to result. 
 
 Influence of History and Capitalization 
 
 It is argued by some that capitalization 
 should be the controlling element upon 
 which to base values for rate fixing pur- 
 poses. At the least this is said to be correct 
 for a property that is sufficiently successful 
 to earn reasonable dividends upon its cap- 
 italization before the advent of rate-fixing. 
 There is a certain element of reason and 
 justice in the claim in its latter form, since 
 it is undoubtedly true that the public bears 
 some responsibility for what has been per- 
 mitted to be done in the past, and investors 
 who have bought stocks and bonds in good 
 faith, upon the assumption that conditions 
 were stable, are entitled to some considera- 
 tion. It Is difficult, however, to find any 
 justification for a fixed rule that would base 
 rates upon capitalization, or upon earnings 
 prior to rate regulation. It seems to the 
 writer that all rates should be based primar- 
 ily upon appraisal of property, including all 
 the tangible and intangible items heretofore 
 mentioned in the final value of the property. 
 It also seems reasonable that depreciation 
 should be subtracted on all items, and that 
 past history should be gone into to determine 
 to what extent if any the cost of intangible 
 items, or at least such of them as would 
 not be duplicated for a newly organized 
 competing corporation, may have been cov- 
 ered by excess earnings, and may therefore 
 be considered as written off. Certain phys- 
 ical items such as real estate, will frequently 
 be appraised at more than original cost, and 
 if an appreciation in one class of property 
 is to be allowed, it seems illogical to fail 
 to consider depreciation on another class 
 of property. 
 
 As we are still considering what we have 
 termed successful corporations it is not 
 necessary now to consider the case where 
 past earnings have not been sufficient to 
 create a proper depreciation fund. This case 
 will be briefly treated under another head. 
 
 If after determining a proper income to 
 be allowed, it be found for a particular cor- 
 poration that its stock and bonds have en- 
 joyed a wide market, and have been gener- 
 ally distributed and would be considerably 
 depreciated by the revenue proposed to be
 
 allowed, then it seems to the writer that a 
 commission may reasonably allow weight 
 to such a state of facts. On the one hand a 
 strict ruling will bring an immediate loss 
 upon the investor, and on the other hand if 
 the strict ruling be not followed a loss is 
 thrown upon the general public, by collect- 
 ing from them higher rates than are neces- 
 sary. A newly organized commission might 
 very reasonably compromise by fixing a 
 term of years at the end of which strict 
 rulings will generally apply, and in the mean- 
 time gradually lower the rates during said 
 term. Such a course does not correct past 
 injustice, but it divides the losses resulting 
 from injustice between the stockholder who 
 has made an unfortunate investment, and 
 the public that permitted the unfortunate 
 conditions to exist. 
 
 Detail of Rates 
 
 In the writer's opinion the revenue col- 
 lected should be based ultimately upon the 
 "present value" (reproducion cost, less 
 straight line depreciation) of all physical 
 and non-physical items of property neces- 
 sary to the service sold. The revenue should 
 be sufficient to cover operating expenses; 
 depreciation charges; and income upon 
 "present value." 
 
 It would seem at first sight that if an 
 agreement be once reached on total revenue 
 to be collected the rate problem would be 
 practically solved. Such is by no means the 
 case. It is hardly too much to say that 
 some of the hardest problems still remain. 
 These problems do not seem to be of such 
 a nature that any general solution may be 
 indicated, but they are well worth discus- 
 sion. For the purposes of the present paper 
 it wall not be attempted to go much further 
 than indicate a few of the things that must 
 be considered. 
 
 For illustration, let us consider the case 
 of a company whose sole business is the 
 manufacture and sale of electricity. There 
 are many public service enterprises that 
 handle a far more complex business, but 
 this will suffice for illustration. It would 
 probably be found that such a company is 
 retailing electricity in small quantities for 
 domestic purposes; that it is supplying 
 energy for small motors over a wide area; 
 current for small stores, scattered through 
 the residence districts of town; lighting for 
 apartment houses over quite a wide area; 
 lighting for hotels and department stores in 
 the business districts; street lighting, prob- 
 ably of at least two kinds; current for elec- 
 tric elevators; current for manufacturing; 
 current for pumping water, and probably 
 also current for operating electric railways. 
 
 Not only is every one of the classes of 
 service mentioned supplied at different cost 
 to the company, considering that particular 
 class of load alone, but the cost of supplying 
 each class is vitally affected by the pres- 
 
 ence of the other classes, i.e., by "diversity 
 factor." Engineers well understand these 
 things, but the general public does not, and 
 so another and quite important factor enters 
 into rale-fixing, namely the attitude of a 
 more or less ill-informed public. One of the 
 most valuable features of continual discus- 
 sions among engineers is that gradually the 
 general public hears in one way or another 
 of what is going on, and in the course of 
 time becomes less ignorant, or even, at the 
 end, may become well informed. 
 
 Those engineers who have happened to 
 be connected with rate-fixing matters where 
 the rulings of a commission have been pre- 
 ceded and followed by general public discus- 
 sion, in the newspapers and on the platform, 
 will realize vividly the necessity for con- 
 sidering the influence of public opinion, if 
 anything useful really is to be accomplished. 
 
 To return to the discussion of classes of 
 service, it will almost invariably be found 
 that the public have no proper conception of 
 the necessary difference in cost per K.W.H. 
 between supplying a householder with light- 
 ing current say to the amount of 20 to 30 
 KWH. per month, current being delivered 
 around 100 volts, and the current measured 
 being used a short time per day while an 
 unmeasured all day loss goes on in the cus- 
 tomer's individual transformer; and the cost 
 per K.W.H. of supplying say 500,000 K.W.H. 
 per month, at say 10,000 volts, to a railway 
 company. Of course it will be generally ad- 
 mitted that there must be a reasonable dif- 
 ference between w^holesale and retail price, 
 but one continually finds a comparison being 
 made between the prices of coal and electric- 
 ity at wholesale and retail; and in commun- 
 ities where the water supply is metered, the 
 difference between the wholesale and retail 
 price of a cubic foot of water is always 
 brought into the argument. It is maintained 
 by some, and to most people very plaus- 
 ibly, that the wholesale and retail ratio in 
 the. case of electricity should not be very 
 different from the wholesale and retail ratio 
 in the case of coal or water. It is rarely 
 pointed out, however, that a company is 
 fairly lucky if a kilowatt hour at 100 volts, 
 measured inside a customer's residence, does 
 not mean pretty nearly two kilowatt hours 
 measured back on the high tension line. 
 
 There have been an almost endless num- 
 ber of schemes of rates based upon the no- 
 tion of taking proper account of the custo- 
 mer's load factor, and of bringing the charge 
 more closely into line with the actual cost 
 of the particular service charged for. It is 
 obvious enough to engineers that rates ought 
 to take account not only of load factor, but 
 of time of day when the customer's demand 
 is greatest. Here again the attitude of the 
 public makes it difficult to use any system 
 that may look a little complex. The com- 
 pany, or the commission, must therefore
 
 consider not only what is tlieoretically beat, 
 and financially expedient, but also what the 
 public will stand for. 
 
 The present author inclines very much 
 toward putting residences using current 
 mainly for lighting, into a single class. Let 
 us say that the shape of the daily load curve 
 is about the same for all such customers. 
 Let us then determine as closely as possible 
 the average actual cost to the company of 
 making and maintaining a connection to a 
 residence, including interest and deprecia- 
 tion on that equipment used solely by one 
 customer and not available for any other 
 customer. Then let us include the cost of 
 bookkeeping, meter reading, etc., and pos- 
 sibly including the cost of magnetizing cur- 
 rent. Then let each customer's bill have 
 printed on it this sum as a "connection 
 charge," irrespective of whether any current 
 be consumed inside the house or not. The 
 usual "minimum charge" may be eliminated, 
 the cost per K.W.H. lowered a little, and the 
 customer may buy, and pay for, as little as 
 a single K.W.H. or as much as he likes. 
 With this system it really makes but little 
 difference in the cost to the company per 
 K.W.H., whether the customer uses 10 or 
 100 K.W.H. per month. It is fair to say that 
 the idea of a connection charge does not al- 
 ways appeal to the public, but if it is best 
 probably the public can be educated to accept 
 it. The use on the other hand of schedules 
 based on "connected load," or on "active 
 rooms," are of great advantage only in case 
 the shape of the load curve can be changed 
 by their use or in case the use of current for 
 other than lighting purposes can be consid- 
 erably increased. It would be of in- 
 terest to know just what effect the 
 use of these two systems, where they are 
 in use, has had on the shape of the 
 load curve of the average house- 
 holder. If any engineers present have exact 
 data bearing on this feature, it is to be hoped 
 that they may give the rest of us the benefit 
 of it. The subject is of the greatest im- 
 portance, and a few reliable figures are 
 worth a good deal of theorizing. Of course 
 there must be a reduced price for large con- 
 sumption, and to take care of this reduction 
 the "block system" now in use in several 
 places seems at least one of the best meth- 
 ods. With the block system each customer 
 of a given class pays a given rate for the 
 first block, a less rate for the second block, 
 a still less rate for the third block, and so 
 on. The method is quickly understood by 
 the public and is well liked where used. 
 
 For a householder whose use of electricity 
 is not mainly for lighting, it now seems to 
 iDe the genei-al practice to install a second 
 meter, and charge a different rate. Perhaps 
 that is the most satisfactory thing to do at 
 present. It seems quite possible that in the 
 
 future such customers may be given a com- 
 bination of a maximum demand meter with 
 a two-rate clock-controlled meter. We must 
 perhaps wait for the inventor to make this 
 sort of thing practicable. It is rather ob- 
 vious that if a correct and simple system 
 of charging could be introduced that would 
 lead customers generally to use current for 
 refrigeration, electric cooking, etc., and 
 would also insure that current were not used 
 for such purposes during the peak load 
 hours, the result would be greatly to the 
 advantage of all. The weak point of all sys- 
 tems that simply encourage consumption 
 is that the increased consumption in some 
 part, and perhaps in large part, may be at 
 the extreme peak for the plant. 
 
 When we leave the field of residence sup- 
 ply, and consider the proper charge for the 
 almost innumerable other uses of electricity, 
 we find that it is rather customary to divide 
 industiies into classes, and to make one rate 
 say for laundries, another rate for brick 
 yards, another rate for planing mills, etc. 
 The rates for different industries seem most- 
 ly to have been made in the past on the 
 basis of what the traffic will bear. Thus 
 for a planing mill, where steam is useful 
 for treatment of material, and where there 
 is enough refuse wood to be disposed of so 
 that fuel may cost little or nothing, the 
 rate is likely to be very low. The rate for 
 an apartment house is sometimes consider- 
 ably lowered if the owner has an isolated 
 plant ready for use. Of course discrimina- 
 tion between different consumers of a single 
 class, such as apartment houses, is now 
 largely done away with by regulation. It 
 is still a very serious question just what 
 classes of business should have separate 
 rates, and what those rates should be. The 
 author is inclined to believe that it is not 
 so very uncommon for electric companies to 
 take business along some particular line at 
 a rate that, if all factors could be correctly 
 figured in, would be shown to produce a net 
 loss. There are frequently cases where an 
 individual consumer really can make his 
 own electricity for a less cost than the com- 
 pany serving his district can afford to sell 
 it to him. There are very many more cases 
 where the consumer thinks he can make his 
 own electricity much cheaper than he really 
 can make it. When the solicitor of the com- 
 pany, who is out to make a recoi-d, finishes 
 his negotiations with such a man, they may 
 have arrived at a rate at which the company 
 might better not take the business. In such 
 a case if a rate-fixing commission takes 
 charge and, by laying down general rules, 
 in effect raises the rate to such favored con- 
 sumers, the result is likely to be a loss of 
 business, and a feeling on the part of the 
 company that it has been injured by "theo- 
 retical" rate-fixing. As a matter of fact the 
 company may instead have been benefited.
 
 It seems to the writer that the effort in 
 apportionins charges among various classes 
 of consumers should be to make each class 
 pay as nearly as possilile the same rate of 
 return to the company on such part of the 
 comitany's plant and working staff as serves 
 the particular class considered. Proper 
 weight, however, must be given to the value 
 of the service to the consumer, and to the 
 price that the consumer can afford to pay. 
 Certain classes of users may be able to pay 
 more than other classes for a K.W.H. con- 
 sumption that may cost the company the 
 same in either case. Such differences in 
 value of service should be considered, as 
 well as differences in cost to supply service. 
 The writer also believes that generally 
 speaking, too much attention is given to 
 total consumption in kilowatt hours, and too 
 little attention is given to load factor, and 
 especially to the shape of the load curve, and 
 that far too little attention is given to 
 classes of load that may exist, or may be 
 developed, and may be kept almos.t wholly 
 off peak. It should be noted that a customer 
 with an irregular load curve, but who is 
 wholly off peak, will probably be more de- 
 sirable, at least on an extensive system, than 
 a customer with 100 per cent load factor. 
 
 The writer would favor the block system 
 of charging in nearly all cases, and, where 
 the size of the bill would justify it, would 
 like to see a maximum-demand meter used. 
 In that case a possible arrangement of 
 blocks and of bills might be something as 
 follows: (the figures are used for illustration 
 only) : 
 
 Form of Bill 
 
 Consumption for 
 month: K.W.H. 
 
 7320 
 
 K.W. hours 
 
 Month of. 
 
 Days I Max. | Prod- 
 I I demand! uct 
 
 30 I m-^^l 4J4^z»»c? 
 
 2880 K.W.H. @ 5c $144.00 
 
 2880 K.W.H. @ 21/20 72.00 
 
 1560 K.W.H. @ 2c 31.20 
 
 7320 K.W.H. for total sum of $247.00 
 
 The preceding bill is for a customer hav- 
 ing a monthly total load factor of a little 
 under 10 per cent. For the same total con- 
 sumption but a better load factor we may 
 assume additional illustrative rates and con- 
 struct a bill as follows: 
 
 Form of Bill 
 
 Consumption for I Month of ... 
 
 month: K.W.H. | 
 
 I Days I Max. ] Prod- 
 7320 I I demand I uct 
 
 K.W. hours I 30 | ^J»-| »8e«//y ^ 
 
 1140 K.W.H. 
 1140 K.W.H. 
 1140 K.W.H. 
 1140 K.W.H. 
 1140 K.W.H. 
 
 5c $ 57.00 
 
 21/20 28.50 
 
 2c 22.80 
 
 l%c 19.95 
 
 114 c 17.10 
 
 1140 K.W.H. @ 114c 14.25 
 
 480 K.W.H. @ Ic 4.80 
 
 7320 K.W.H. for total sum of $1(;4.40 
 
 The iirocedinj; tornis, of course, are simply 
 equivalent to combining the block system 
 with the method already used rather exten- 
 sively of charging a rate depending upon 
 the "hours use of maximum demand." 
 
 To a limited extent it is possible to take 
 care of differences in the time of day of 
 maximum demand, by varying the rate for 
 various classes of service. Some businesses 
 require current only during definitely fixed 
 hours. There are objections to such ^classi- 
 fications, and indeed to complications of any 
 sort in the rate. It seems to be generally 
 conceded however that it is going to be 
 necessary to include either maximum de- 
 mand directly measured, or to introduce 
 some quantity such as installed capacity, or 
 active installation; quantities which are as- 
 sumed to be approximately proportional to 
 maximum demand. As maximum demand 
 meters are not excessively expensive it 
 would seem that their use should be favored 
 where possible. 
 
 It should be noted that it is not really 
 maximum-demand of any particular custo- 
 mer that seriously affects the company. The 
 company is only seriously affected by the 
 coincidence of time of the maximum de- 
 mands of a large number of customers. If 
 a given consumer has his maximum-demand 
 off peak, the size of that demand is not a 
 serious matter. Perhaps we may come to 
 a combination of clock and maximum de- 
 mand meter, and base the bill upon equiva- 
 lent hours' use of that maximum demand or 
 average maximum demand, which occurs 
 during peak load of the plant, paying no 
 attention to what the maximum demand may 
 be at other times of day. 
 
 A rate-fixing commission should meddle as 
 little as possible with such rate details as 
 have been mentioned under the present 
 heading, although a commission should b^ 
 ready to advise upon such matters at the 
 request of any company. A commission's 
 advice ought to be very valuable, for the 
 commiFsion should be in a position to know 
 what is being done all over the country, 
 while the officers of a single corporation 
 may be so occupied with administrative de- 
 tail as to have little time for investigations. 
 While a commission therefore should be 
 prepared to give voluminous and detailed 
 advice upon request, it does not seem proper 
 that a commission should interfere in detail 
 matters between a company and its custom- 
 ers except where such interference is really 
 necessary for the protection of the public. 
 Unsuccssful Utilities 
 The problem of the unsuccessful utility, 
 or of the utility that has been unsuccessful 
 
 10
 
 in its early years but afterwards becomes 
 self-supporting or better, is very puzzling. 
 There are certain general features, however, 
 that seem usually to be overlooked. In the 
 first i)lace it will be generally recognized 
 that as an abstract proposition it is no part 
 of the functions of government to prevent 
 its individual citizens from losing money 
 (except by preventing fraud and through 
 the general dissemination of information 
 and advice, etc. The citizen who invests un- 
 wisely in a public utility is no moi-e entitled 
 to ask the government to collect his loss 
 from the community, than is the citizen who 
 invests unwisely in a grocery store. To go 
 a little farther, if investors misjudge a sit- 
 uation and create an enterprise that would 
 be profitable ten years later, such investors 
 are not entitled to collect from the future 
 community tbe early losses that came from 
 their own poor judgment. This does not at 
 all mean that a company is not to be allowed 
 a reasonable time to establish itself, or that 
 the reasonably determined cost of estab- 
 lishing a business is not to be capitalized, 
 and paid for by the public. Such costs 
 should be so capitalized and paid for. There 
 should be a clear distinction made between 
 the cost of establishing a successful busi- 
 ness, and the losses following an ill-con- 
 ceived or premature enterprise. This is an 
 extremely important matter, and should have 
 much more attention than thas generally 
 been given to it. A commission must be lib- 
 eral in allowances for building up a business, 
 or projects will not be undertaken. At the 
 same time a commission must guard care- 
 fully against making the public pay for such 
 misjudgment as in any but a public service 
 enterprise would simply mean personal loss 
 to the man who has misjudged. 
 
 In every rate discussion it is pointed out 
 that an investor in public service securities 
 must have an increased return because of 
 the risk that he runs of losing his money. 
 This is perfectly correct. , The same gentle- 
 men who bring out this idea of excess com- 
 pensation for risk, will not infrequently in 
 effect take the position that rate-making bod- 
 ies must see that no investor in any public 
 utility is permitted by any chance to lose 
 money. The two propositions are incompat- 
 ible. An investor should not be compen- 
 sated for risk unless there is risk. If the 
 
 government makes the rule that such in- 
 vestors must never lose, then there is no 
 risk in the investment, and no occasion for 
 excess compensation. The fact is that we 
 must recognize frankly that there is a risk 
 to any business and that risk is the risk pf 
 losing money. This means that some of the 
 people who engage in that particular kind 
 of business are going to actually lose money. 
 Also it means that the excess compensation 
 to those who succeed must seem to the 
 investor to bear a reasonable relation io 
 the chances of failure, i.e., to the proportion 
 of total money in similar enterprises that 
 in fact is lost. 
 
 Now for an enterprise that is in advance 
 of the development of the community, and 
 therefore must necessarily be losing money, 
 and where rates based on proper return to 
 capital, provision for depreciation, etc., are 
 uncollectable, or are more than the commun- 
 ity will pay before going without the service, 
 the reasonable rate seems to be "what the 
 traffic will bear." That is to say, the rate 
 must be the one that will bring in the most 
 possible revenue. The corporation in such 
 case should be allowed to exercise its own 
 judgment in fixing the rates, the commission 
 only acting as an advisor. 
 
 When the community catches up to the 
 utility. It seems to the writer perfectly just 
 that the commission should then value the 
 tangible and intangible values (as depreci- 
 ated or appreciated), including such a "go- 
 ing value" as would apply to such a business 
 if built up in a community that might sup- 
 port it. It seems perfectly just that reven- 
 ues and rates be then based on the appraised 
 value. As to the excess losses of early 
 years, or the losses due to depreciation not 
 having been met in earlier times, those 
 losses should not in the case outlined, be 
 forced on the public. It is not recommended 
 that there should be any abrupt change of 
 rates at any particular period of growth, but 
 that as the community becomes able to sup- 
 port the utility such a gradual change in 
 rates should occur as will eventually bring 
 the public and the utility into the same 
 financial relationship as they would have 
 enjoyed had the utility been constructed at 
 a time when the public was ready for it, and 
 had it therefore been successful from the 
 start. 
 
 11 
 
 251351
 
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