Court Opinion

ID: 4066010
Source: CourtListenerOpinion
Date Created: 2016-09-29 22:21:43.656411+00
Date Added: 2024-06-11T09:26:23.777227
License: Public Domain

ACCEPTED
                                                                                         03-14-00706-CV
                                                                                                 5234415
                                                                              THIRD COURT OF APPEALS
                                                                                         AUSTIN, TEXAS
                                                                                    5/11/2015 3:11:14 PM
                                                                                       JEFFREY D. KYLE
                                                                                                  CLERK
                              NO. 03-14-00706-CV

                   IN THE THIRD COURT OF APPEALS       FILED IN
                                                 3rd COURT OF APPEALS
                            AUSTIN, TEXAS            AUSTIN, TEXAS
                                                               5/11/2015 3:11:14 PM
                           ENTERGY TEXAS, INC.,                  JEFFREY D. KYLE
                                      Appellant                        Clerk

                                        v.

               PUBLIC UTILITY COMMISSION OF TEXAS,
                                  Appellee

             APPELLANT ENTERGY TEXAS, INC.’S
      MOTION FOR THE COURT TO TAKE JUDICIAL NOTICE
     AND RESPONSE TO STATE AGENCIES’ MOTION TO STRIKE

TO THE HONORABLE THIRD COURT OF APPEALS:

      Appellant Entergy Texas, Inc. (“ETI”) files this motion for the Court to take

judicial notice and response to Appellee State Agencies’ Motion to Strike Portions

of ETI’s Reply Brief. In support of its own motion, and in opposition to State

Agencies’ motion, ETI shows this Court as follows.

      This is a suit for judicial review of the final order of the Public Utility

Commission of Texas in its rate case expense Docket No. 40295. ETI challenges

the Commission’s decision principally because it is an unexplained, after-the-fact

departure from prior Commission practice in two different respects. First, ETI

pointed out that the Commission has never before disallowed the rate case

expenses associated with making unsuccessful arguments about financially-based
incentive compensation.     See ETI’s Appellant’s Brief at 17-18.        Second, ETI

pointed out that the Commission has never before used a “proxy” to quantify a

disallowance for rate case expenses. See id. at 27-28. In support of both these

arguments, ETI cited several prior Commission decisions to show what the

Commission’s prior practice has been. See id. at 17-18, 27-28, & Appendix D.

This Court has specifically acknowledged it may consider how the Commission

has treated other utilities in past dockets to determine whether a particular policy is

new in a given case. The Court so ruled even though the Commission’s decisions

in the past dockets were not part of the administrative record in the contested case

under review. See Oncor Elec. Delivery Co. LLC v. Public Util. Comm’n of Tex.,

406 S.W.3d 253, 267 (Tex. App. – Austin 2013, no pet.).

      In its Appellee’s Brief, the Commission argued its allowance of rate case

expenses in previous dockets is distinguishable because the utilities’ arguments in

those cases were different from ETI’s argument in this case. See Commission’s

Appellee’s Brief at 33.     The Commission said ETI “shows no examples” of

previous cases analogous to this one. Id.

      The Commission also argued that its use of a proxy in this case was

consistent with the way it quantified a disallowance in another docket. See id. at

44. Specifically, the Commission argued that it disallowed fifty percent of the

expenses associated with the testimony of Cities’ witness Dr. Goodfriend in

                                            2 
 
Docket No. 28840. The Commission suggested that the percentage disallowed did

not reflect the actual expenses associated with the witness’s flawed testimony. Id.

at 45-46. State Agencies made the same argument in their Appellee’s Brief. See

State Agencies’ Appellee’s Brief at 26.1

              To correct Appellees’ assertions about these matters (which are outside the

administrative record), ETI provided more detail about the previous Commission

dockets at issue. ETI appended to its Reply Brief copies of its witness’s testimony

about financially-based incentive compensation in two previous dockets. These

documents show that ETI made the same arguments about incentive compensation

in those two dockets as it did in this case. See ETI’s Reply Brief at Appendices A

& B.               These documents were presented to directly refute the Commission’s

characterization of the arguments made in previous dockets.

              ETI also provided a link in its Reply Brief to the testimony of Dr.

Goodfriend in Docket No. 28840. This document shows that the Commission’s

disallowance of fifty percent of the expenses of this testimony correlates almost

exactly to the portion of the witness’s testimony that the Commission determined

was “flawed.” This document, too, was presented to directly refute the arguments
                                                            
1
  Docket No. 31433, cited by State Agencies, is the rate case expense docket severed from rate
case Docket No. 28840. See Proceeding to Consider Rate Case Expenses Severed from Docket
No. 28840 (Application of AEP Texas Central Company for Authority to Change Rates), Docket
No. 31433. As both the Commission and ETI have pointed out in briefing, most public filings at
the Commission are available on the Commission’s interchange at:
http://interchange.puc.texas.gov/WebApp/Interchange/application/dbapps/filings/pgSearch.asp .
The “Control Number” is the Docket Number for each proceeding.
                                                               3 
 
that the Commission and State Agencies made about the basis for the disallowance

in that previous case.

      Nevertheless, State Agencies have moved to strike not only these

documents, but the portions of ETI’s brief that mention them. This Court should

deny State Agencies’ motion and take judicial notice of the documents at issue.

      ETI has not presented these documents in support of the truth of their

content. ETI has presented the documents only to establish that they were filed,

and the nature of the matters the witnesses discussed, in prior dockets. These

documents were filed with the Commission, a state agency. They are publicly

available, and their authenticity is readily verifiable. This Court can, therefore,

take judicial notice of these documents for the limited purposes ETI presents them.

Tex. R. Evid. 201(b); Freedom Communications, Inc. v. Coronado, 372 S.W.3d
621, 623 (Tex. 2012); Office of Pub. Util. Counsel v. Public Util. Comm'n, 878
S.W.2d 598, 600 (Tex. 1994); Vickers v. State, No. 06-14-00072-CR, 2015 WL
1882910, *6 n.11 (Tex. App. – Texarkana Apr. 27, 2015, no pet. h.); Katy Intern.,

Inc. v. Jinchun Jiang, 451 S.W.3d 74, 94 n.20 (Tex. App. – Houston [14th Dist.]

2014, no pet. h.); Hendee v. Dewhurst, 228 S.W.3d 354, 377 n.30 (Tex. App. --

Austin 2007, pet. denied).

      State Agencies also curiously complain that ETI has not provided “specific

citations” for these documents. The existence and location of these documents in

                                         4 
 
the Commission’s files are clear from ETI’s Reply Brief, as the documents

themselves are attached to the brief. However, to dispel any concern that the

documents attached to ETI’s Reply Brief are not authentic, readily-verifiable

public documents, ETI attaches certified copies of the documents to this motion. A

certified copy of the document that appears as Appendix A to ETI’s Reply Brief

(Dr. Hartzell’s Direct Testimony in Docket No. 34800) is attached to this motion

as Appendix A.2 A certified copy of the document that appears as Appendix B to

ETI’s Reply Brief (Dr. Hartzell’s Direct Testimony in Docket No. 37744) is

attached to this motion as Appendix B. A certified copy of Dr. Goodfriend’s

testimony in Docket No. 28840, to which ETI linked in its Reply Brief, is attached

to this motion as Appendix C.3

              ETI respectfully requests the Court take judicial notice of the nature of the

content of the following documents, and the fact they were filed in the following

Commission dockets:

                            Direct Testimony of Jay C. Hartzell, Ph.D., EGSI Remand
                             Exhibit No. 72, in Public Utility Commission Docket No.
                             34800;

                                                            
2
  This testimony was first filed as part of Entergy Gulf States, Inc.’s application in Docket No.
34800 and is also available on the Commission’s interchange, Application of Entergy Gulf
States, Inc. for Authority to Change Rates and to Reconcile Fuel Costs, Docket No. 34800, Item
1, Bates No. 5531, at:
http://interchange.puc.state.tx.us/WebApp/Interchange/Documents/34800_1_563631.PDF .
3
  This testimony is also available on the Commission’s interchange, Application of AEP Texas
Central Company for Authority to Change Rates, Docket No. 28840, Item 338, at:
http://interchange.puc.state.tx.us/WebApp/Interchange/Documents/28840_338_425996.PDF .
                                                               5 
 
            Direct Testimony of Jay C. Hartzell, Ph.D., ETI Exhibit No. 14,
             in Public Utility Commission Docket No. 37744; and

            Redacted Direct Testimony of Sarah J. Goodfriend, Ph.D., filed
             February 9, 2004, on behalf of Cities Served by AEP Texas
             Central Company, in Public Utility Commission Docket No.
             28840.

ETI also respectfully requests this Court overrule State Agencies’ motion to strike

these documents and the sentences of ETI’s reply brief that discuss them. ETI

further requests any other relief to which it may show itself justly entitled.

                                 Respectfully submitted,

                                 DUGGINS WREN MANN & ROMERO, LLP

                                 By:     /s/ Marnie A. McCormick
                                       John F. Williams
                                       State Bar No. 21554100
                                       jwilliams@dwmrlaw.com
                                       Marnie A. McCormick
                                       State Bar No. 00794264
                                       mmccormick@dwmrlaw.com
                                       P. O. Box 1149
                                       Austin, Texas 78767-1149
                                       (512) 744-9300
                                       (512) 744-9399 fax

                                       ATTORNEYS FOR APPELLANT
                                       ENTERGY TEXAS, INC.

                                           6 
 
                      CERTIFICATE OF CONFERENCE

      I certify that I have conferred with counsel representing the Public Utility

Commission of Texas, State Agencies, and the Office of Public Utility Counsel,

and they oppose this motion. Counsel for Texas Industrial Energy Consumers, an

intervenor in the district-court proceeding, does not agree to or oppose this motion.

                                               /s/ Marnie A. McCormick
                                               Marnie A. McCormick

                                          7 
 
                         CERTIFICATE OF SERVICE

       The undersigned counsel certifies that the foregoing document was
electronically filed with the Clerk of the Court using the electronic case filing
system of the Court, and that a true and correct copy was served on the following
lead counsel for all parties via electronic service on the 11th day of May, 2015:

Elizabeth R. B. Sterling
Environmental Protection Division
Office of the Attorney General
P. O. Box 12548 (MC 066)
Austin TX 78711-2548
Counsel for Appellee Public Utility Commission of Texas

Rex D. VanMiddlesworth
Benjamin Hallmark
Thompson Knight LLP
98 San Jacinto Blvd., Ste. 1900
Austin TX 78701
Counsel for Intervenor Texas Industrial Energy Consumers

Katherine H. Farrell
Sara R. Hammond
Administrative Law Division
Office of the Attorney General
P. O. Box 12548 (MC018-12)
Austin TX 78711-2548
Counsel for Appellee State Agencies

Ross Henderson
Office of Public Utility Counsel
1701 N. Congress Ave., Ste. 9-180
P. O. Box 12397
Austin TX 78711-2397
Counsel for Intervenor Office of Public Utility Counsel

                                       /s/ Marnie A. McCormick
                                      Marnie A. McCormick

                                         8 
 
             APPENDIX A

Direct Testimony of Jay C. Hartzell, Ph.D
         PUC Docket No. 34800
                                                     SOAH Docket No. XXX-XX-XXXX
                                                        PUC Docket No. 34800
                                                       EGSI - 2007 Rate Case

                                                 · EGSI Exhibit No,; 721 11 ,:              •

                         DOCKET NO.       3L/l:300                .       ;>.·.. ,•)"',,   rJ
                                                                             HH.l   3

 APPLICATION OF ENTERGY               §      PUBLIC UTILITY COMMISSION .·
 GULF STATES, INC. FOR                §
 AUTHQRITY TO CHANGE RATES         §
 AND TO RECONCILE FUEL COSTS      .§                  OF TEXAS

                           DIRECT TESTIMONY

                                  OF

                            JAY C. HARTZELL

                             ON BEHALF OF

                       ENTERGY GULF STATES, INC.

                           SEPTEMBER 2007

2007 Texas Rate Case                                       10-1
                              DOCKET N O . - - - -

                          ENTERGY GULFSTATES, INC.
                     DIRECT TESTIMONY OF JAY C. °HARTZELL.
                            2007 TEXAS RATE CASE

                                TABLE OF CONTENTS

                                                                            Page.

 I.     Witness Identification and Qualifications                              1

 II.    Purpose and Organization of Testimony ·                                2

 Ill.   Financial-Based Incentive Compensation as a Tool for Improving
        Consumer Welfare                                                       4

        A.       The Positive Effect of Incentive Compensation on Utility
                 Customer Welfare                                              4
        B.       The ReasC?ns for Providing Financial-Based Incentive
                 Compensation                                                 10

                                       EXHIBIT

 Exhibit JCH-1         Resume

2007 Texas Rate Case                                                10-2
       Entergy Gulf States, Inc.                                                 Page 1of19
       Direct Testimony of Jay C. Hartzell
       2007.Texas Rate Case

 1                 I.      WITNESS IDENTIFICATION AND QUALIFICATIONS

 2      Q.     PLEASE       STATE      YOUR     NAME, OCCUPATION, AND            BUSINESS

 3             ADDRESS.

 4 A. I cim Jay C. Hartzell.        I am an Associate Professor of Finance at the

 5             Mccombs School of Business .at the University of Texas at Austin.        My

 6            work address is Department of Finance, T.he University of Texas at Austin,

 7             1 University Station 86600, Austin, Texas, 78712.

 8

 9     Q.     FOR WHOM ARE YOU TESTIFYING?

1.0    A.     I am testifying on behalf of Entergy Gulf States, Inc. ("EGSI").

11

12     Q.     PLEASE        DESCRIBE YOUR EDUCATIONAL               BACKGROUND AND ·

13            PROFESSIONAL EXPER1ENCE.

14 A. I provide my complete resume in my Exhibit JCH..1. In brief, I obtained a.

15            Bachelor of Science degree (cum laude) from Trinity University in May

16            1991, with majors in. Business Administration and Economics.            After

17            graduating, I went to work as a consultant for Hewitt Associates, in The

16            Woodlands, Texas .. Hewitt is a «>nsulting firm that specializes in benefits

19            and compensation.          While there, I specialized in the area of defined

20            contribution plans. I left Hewitt to go to graduate school at the University

21            of Texas at Austin in 1993. I compfeted my PhD in finance there in May

22            1998. Upon graduating, I took a job as an Assistant Professor of Finance

23            at New York University's Stem School of Business, where I worked

      2007 T-exas Rate Case                                               10-3
       Entergy Gulf States, Inc.                                                        Page2of 19
       Direct Testimony of Jay C. Hartzell
       2007 Texas Rate Case

 1             until 2001. At that time, the University of Texas at Austin hired me as an

 2             Assistant Professor at the .Mccombs School of Business ("Mccombs

 3             School"), where I have worked since.            I was promoted to the rank of

 4             Associate Professor (with tenure), effective in the fall 2006. I also now

 5             serve as the Director of the Real Estate Finance and Investment Center at

 6             the Mccombs School.

 7

 8     Q.      WHAT ARE YOUR MAIN AREAS OF RESEARCH?

 9     A.      My primary research interest is in the area of corporate governance. This

10             area encompasses several topics, including executive compensation, the

11             role of institutional investors, mergers and acquisitions, and boards of

12             directors.. I have also written papers in the. area of real estate finance, with

13             many of these· also focusing on the areas of corporate governance, using

14             data from that industry.

15

16                  II.     PURPOSE AND ORGANIZATION OF TESTIMONY

17     Q.     WHAT· IS THE PURPOSE OF YOUR TESTIMONY?

18     A.      EGSI has asked me to comment on the use of financial-based goals in a

19            company's incentive compensation plans, and how those goals affect

20.           consumer welfare.        I first address the factors specific to the utility industry

21            that support the conclusion that the presence of financial-based goals in

22            an incentive compensation plan is consistent with ronsumers' interests. I

23            then turn to the broader topic of how an incentive -compensation plan

      2007 Texas Rate Case                                                       10-4
      Entergy Gulf States, Inc.                                                   Page3of 19
      Direct Testimony of Jay C. Hartzell
      2007 Texas Rate<;ase

 1            including financial measures provides incentives to a firm's employees to

 2            take actions that improve customer welfare.

 3

 4    Q.      WHY ARE YOU QUALIFIED TO ADDRESS THESE SUBJECTS AND TO

 5            PROVIDE THIS TESTIMONY?

 6    A.      In addition to my formal training as a student, I have studied and

 7            conducted research on corporate governance, including executive

 8           compensation, for more than 10 years, starting with work in graduate

 9           school, including my dissertation.     Since that time, I have written nine

10           papers on corporate governance topics, plus my dissertation. Six of those

11           have been published in peer-reviewed academic journals, including the ·

12           top such journals in the field of finance. · I have presented and discussed

13           papers on corporate governance (including compensation) at the major

14           conferences in the field. I have also taught related topics   to PhD students;

15           as part of a PhD class in empirical corporate finance.

16

17    Q.    .DO YOU SPONSOR ANY EXHIBIT?

18    A.     Yes. My exhibit is listed in the table of contents to this testimony.

     2007 Texas Rate Case                                                  10-5
       Entergy Gulf States, Inc.                                                         Page4of 19
       Direct Testimony qf Jay C. Hartzell
       2007 Texas Rate Case

 1          Ill.     FINANCIAL-BASED INCENTIVE COMPENSATION ASA TOOL FOR
 2                               IMPROVING CONSUMER WELFARE

 3     Q.          WHAT      IS    YOUR      UNDERSTANDING          OF    THE    COMMISSION'S

 4                 RATEMAKING           TREATMENT        OF     A        UTILITY'S      INCENTIVE

·5                 COMPENSATION EXPENSES?

 6     A.          It is my understanding that in recent cases, the Public Utility Commission

 7                 has had a policy of excluding from base rates compensation that        is based
 8                 on the firm's financial measures, but has allowed compensation that is

 9                 based on operational measures such as quality of service, reliability,

10                 public safety, cost control, power plant performance, reduction .of

11                 absenteeism, and cost containment.

12

13     Q.          WHAT ISSUES REGARDING INCENTIVE COMPENSATION WILL YOU

14                 ADDRESS?

15 A. I will comment on the coexistence of these two types of incentives

16                 (financial-based and operational-based), and the role of financial-based

17                 incentives in ultimately contributing to customer welfare.

18

19                      A.        The Positive Effect of Incentive Compensation on
20                                            Utility Customer Welfare

21     Q.          IS THERE A LINK BETWEEN CUSTOMER WELFARE AND A FIRM'S

22                 FINANCIAL PERFORMANCE?

23    A.           Yes. Satisfied customers clearly experience greater customer welfare, all

24                 else equal, as they are happy with the pr-0ducts they consume. This is

     . 2007 Texas Rate Case                                                      10-6
         :Entergy Gulf States, Inc.                                                   Page5of 19
          Direct Testimony of Jay C. Hartzell
         2007 Texas Rate Case

  1              true not only for customers in unregulated industries, but also for

  2              customers in regulated industrieS.           For example, customers who

 3               experience fewer power outages will suffer less disutility from being

 4               without power, but will also spend iess time and expend· fewer ·resources

 5               compensating for outages, or complaining about the service they have

 6               received.

 7                       In addition to benefiting -customers, greater satisfaction tends to

 8               benefit the firm, as well. Satisfied customers are likely to buy more of the

 9               firm's products, which leads to higher revenues and profits,    and a higher
10               stock price, all else equal. Satisfied customers are also more likely to be

11               retained as customers, and customer retention helps the firm's profitability

12 .             via higher net revenues than they would have experienced without such .

13               satisfaction. Companies with better reputations for customer satisfact.ion

14               are also more likely to attract new customers who can learn of firms'

15 .·            reputations prior to making their purchasing decisions. At the same time,

16               because improved customer satisfaction tends to lead to improved

17              financial performance, the prospect for improved financial results can .play

18              a positive role in motivating   manag~rs   to improve customer welfare.

19                       Although regulated utilitfcompanies do not deal with the same type

20              of competitive dynamics faced by unregulated companies, the general

21              concepts related to customer satisfaction still apply.          For example,

22              potential- industrial customers and other large users face choices when·

23              they decide where to locate a new facility {a factory, a :eampus, etc.) or

        2007 Texas Rate Case                                                  1-0-7
        Entergy Gulf States, Inc.                                                   Page6of19
        Direct Testimony of Jay C. Hartzell
        2007 Texas Rate Case

  1            . whether to expand a current facility or instead build a new one, or whether

  2             to produce their own power rather than rely·on the locaJ utility company.'

  3             Holding the rates they are offered constant, if the customer has a facility in

  4             a location with an electricity provider who provides good service, then the

  5             c·ustomer's satisfaction with that service would make the customer more

  6             likely to expand that facility, and would make the customer less likely to

  7             look for <;ilternative locations or to self-generate, all else equal. · A

  8             customer that is more likely to expand in the current location rather than .

  9             look elsewhere would in tum benefit ·the financial performance of the

 10             customer's current utility company.

 11                       This conceptual link between customer welfare and financial

 12             performance also applies to residential utility customers.          Residential

 13             customers. can choose, for example, between gas (including propane)

 14             appiiances and electrical appliances. The more· satisfied they are with

 15            their electrical service provider, the more likely they are to choose

 16.           electrical appliances (all else equal). This customer behavior in response

 17           . to good service again leads to better financial performance for the electric

 18            utility.

 19
. 20.· Q.      WHY        WOULD       TODAY'S   FINANCIAL      HEALTH      OF    THE     FIRM

 21            POSITIVELY AFFECT FUTURE CUSTOMER WELFARE?

       2007 Texas Rate Case                                                  10-8
      Entergy Gulf States, Inc.                                                  Page7of 19
      Direct Testimony of Jay C. Hartzell
      2007 Texas Rate Case

 1 A. I can see at least five channels through which a more financially

 2            successful company will be associated with greater customer welfare both

 3            now, and in the future.

 4                    First, companies that are financially healthy will ·be able to raise

 5            capital at lower cost. Put another way, companies that are !ass healthy

 6            financially and therefore are more likely to enter into financial distress

 7            (including bankruptcy) will face higher costs of capital. These higher costs

 8            of capital will in tum lead to higher rates for customers and loWBr .customer

 9            welfare. This channel is straightforward:     as a .company gets closer to

10            distress, the expected costs of distress increase, and· 1en6ers (including

11            bondholders) char.ge more for their loans to the firm. Because the cost of

12           debt is one of the key components of the cost of capital, these higher

13           borrowing costs lead to a higher overall cost of <:apital. In addition; if ·the

14           higher costs of capital are large. enough, this .effectively limits the less

15           healthy firm's access to funds, implying that financially healthy. firms have

16           broader access to capital than their less healthy counterparts. This rost of

17           capital effect is especially .relevant to the utility industry given the

18           industry's reliance on large capital spending projeots and use of debt

19           capital.

20                  · Second, in an industry where prices that firms can charge are

21           regulated, if managers have incentives to increase fmancial performance,

22           then this will lead them to focus on cutting oosts. By linking managers'

23           pay to stock price, for example, managers will, among other goals, attempt        ..   ;

     2007 Texas Rate Case                                                 l0-9
       Entergy Gulf States, Inc.                                                  Page8of 19
       Direct Testimony of Jay C. Hartzell
       2007 Texas Rate Case

 1             to increase stock price by operating mere efficiently.      This improved

 2             effiCiency will lead to a lower cost basis in the future than what one would

 3             have observed without such incentives, which will in turn lead to lower

 4            future prices for customers (compared to .what would likely have been

 5            charged otherwise) and increased customer welfare.

 6                     Third, the utility industry is characterized by high fixed costs of

 7             production and economies of scale. This cost structure implies that larger

 8            firms can operate at lower marginal, costs (all else equal). Thus, as higher

 9            customer service or satisfaction leads to greater customer attraction and

1O             retention, these in tum lead to growth in the customer base and revenues.

11            The magnitude of these effects may be smaller for a regulated utility than

12            for a firm in an unregulated industry, but I see no reason why the effects

13            would not still be present and go in the same direction. Such growth in ,

14            reven~es is associated with greater financial performance, but the

15            increase in size allows the firm to produce more cheaply due to the large

16            fixed costs in the industry and economies of scale. These cost sayings

17            again materialize in lower future rates for customers (compared to what

18            they would have been without the growth in the firm's operations).

19                    Fourth, managers who care about the financial performance of the

20            company are more likely to make better investment decisions. The stock

21            market, via analysts who follow the firm's behavior and traders who act

22            based on their beliefs about the firm's prospects, acts as a monitor of a

23            wide range of managerial actions, including investment decisions. Stock-

     , 2007 Texas Rate Case                                               10-10
         Entergy Gulf States, Inc.   ,                                                  Page9of 19
         Direct Testimony of Jay-C. Hartzell
         2007 Texas Rate -Case

   1              price based incentives can help discipline managers, and constrain ·them

   2              from investing in ways that might not benefit the firm.

   3                       Fifth, companies that are less healthy financially - or, to put it

  4             · another   w~y,   closer to financial distress - will likely experience greater

   5              costs, which will in turn be passed on to customers.         This is because

  6               stakeholders who have relationships with the company will demand more

  7               favorable terms from the firm in order to compensate them for the greater

  8               risk of dealing with a less healthy company. For example, consider a

  9               supplier who sells machinery to a utility company that is not financially

 10              healthy (or is believed to be near distr-ess). Such a supplier will likely

 11              demand higher prices from the utmty before. committing to any sort .of

 12              investment in a relationship with the utility, in order to compensate for the

 13              risk that the revenues from the relationship may cease to exist before the

 14              supplier can recoup its costs. These effects are predicted to be stronger

 15              where firm-sp.eciftc investments are required - such as customized

· 16             machinery - or, the relationship is expected to have a longer term. In

 17              addition, suppliers to less healthy firms (ftrms that are nearer-distress) are

 18              likely to pr-ovide less attractive terms of trade - for example,   r..equiring~h

 19              payment rather than accepting tracle credit. Both of these - higher prices

20               or worse trade and -credit terms - will materialize as higher -costs for the

 21 ·            utility, which will in turn likely be passed on to customers via higherpriGes

 22              for €nergy. · Similar arguments can be made for other stakeholders-Of the

23               firm, such as employees of the firm. Employ.0es of firms that          are   more

        2007   T~xas   Rate Case                                               1-0-11
      Entergy Gulf States, Inc.                                                    Page 10of 19
      Direct Testimony of Jay C. Hartzell
      2007 Texas Rate Case ·

 1               likely to become financially distressed will likely demand higher wages in

 2               order to compensate them for the risks they face in working for such a

 3               company. Absent a s1:1fficient wage differential, financially distressed firms.

 4               are likely to lqse skilled and talented employees and to find it difficult to

 5               attract good new ones, further exacerbating these firms' situations.

 6                      In summary, by providing managers with incentive compensation

 7              · that is based in part on the financial performance of the firm, managers

 8               have incentives to keep the firm financially healthy. A utility's financial

 9               health is very likely to benefit customers via lower costs than otherwise

10               would be experienced, which in tum lead to lower rates than otherwise

11               would be the case. These lower costs occur because of (i) a lower cost of

12               capital; (ii) more efficient operations; (iii) greater scale of production;

13               (iv) better investment decisions by managers; and (v) better prices and/or

14               terms from stakeholders, such as suppliers and employees.

15

16         B.      The Reasons for Providing Financial-Based Incentive Compensation

17    Q.         WHAT TOPICS DO YOU DISCUSS IN THIS SUBSECTION OF YOUR

18              TESTIMONY?

19 A. I explain how incentive compensation is used as an effective tool in

20              aligning the interests of a firm's employees and its stakeholders, including

21              the ·firm's customers and shareholders. I also discuss how this improved

22              incentive alignment motivates a firm's employees to take actions that tend

23              to ultimately benefit the firm-including customers and shareholders.

     2007 Texas Rate Case                                                    10-12
        Entergy-Gulf States, Inc.                                                  Page 11of19
        Direct Testimony of Jay C. Hartzell
        2007 Texas Rate Case

   1    Q.      WHAT IS THE             BASIC    UNDERLYING THEORY Of INCENTIVE

   2            COMPENSATION             AS     IT APPLIES      TO    A   PUBLICLY-TRADED

   3            COMPANY?

   4    A.      The traditional paradigm of incentive-based compensation centers around

   5            the role of incentive pay in solving a "moral hazard" problem, wher.e the

   6            principals involved cannot observe the actions of an agent who acts on

   7           their behalf. This     ag~nt   is expected to act in a way that maximizes his or

   8           her personal welfare, which is not necessarily the same set of actions that

   9           would maximize the welfare of the principals. This potential conflict of

 10            inter.est, termed an agency problem, gives rise to a role for incentive

 11            compensation. Because the principals cannot observe or write contracts

 12            based on the agent's actions (because it is assumed that those actions

 13            cannot be observed or legally verified), incentives are put in place such

 14            that the agent is more likely to benefit when they tak.e the-course of action

 15            that is desired by the principals. Specifically, the agent receives higher

 16            pay . when      he or she takes actions· that benefit the principals.

 17            Understanding this, the agent is mor,e likely to take those actions desir.ed

 18            by the principal - put forth more effort, -pick better projects, or shirk less,

 19            for example.

 2-0                   The typical view in finance is from the -perspective of the

 21            shareholders: shar.eholders ar.e the principals and owners of the firm, and

. 22           they hire managers to act as agents on their behalf, Incentive pay has a

 23            role in that it provides for greater compensation to managers when there

       2007 Texas Rate.Case                                                   10-13
        Entergy Gulf States, Inc.                                              Page 12of 19
        Direct Testimony of Jay C. Hartzell
        2007 Texas Rate Case

 1              are indications that they took actions that benefited shareholders. One of

 2              the most fundamental and accepted theoretical results from the principal-

 3              agent academic literature is that an agent's pay· should be linked to a

 4              particular performance measure (such as stock price, accounting profits,

 5             or a score based on customer satisfaction) if that measure provides an

 6             additional informative signal of the manager's actions.

 7                      If a principal (such as the Commission) has a goal of maximizing

 8             customer welfare, then the same principal-agent theory still applies.       In

 9             this context, pay should optimally be related to any performance measure

10             that contains marginally useful informatiori about whether managers acted

11             in a way that is consistent with maximizing customer welfare.         In other

12             words, even if the goal is to maximize customer welfare, pay should also

13             be related to. financial performance so long as the financial perfonTiance

14             measures contain some additional information about custor:ner welfare.

15

16     a.      HOW CAN INCENTIVES BASED ON FINANCIAL MEASURES IMPROVE

17             MANAGER.S' FOCUS. ON CURRENT AND FUTURE C.USTOMER

18            ·SERVICE?

19     A.      lri the extreme, this most basic principal-agent theory is developed in a

20             one-'period setting, without regard to future periods. In this set-up, the

21 .           manager acts, outcomes are realized at the end of the period (depending

22             in part on those actions), and the manaQer receives his or her pay.

     . 2007 Texas Rate Case                                               J0-14
       Entergy Gulf States, ~nc,                                                 Page 13of19
       Direct Testimony of Jay C. Hartzell
       2007 Texas Rate-Case

 1                     A more realistic setting would allow for multiple periods, where both

 2             managers arid principals would have to consider not only their immediate

 3             actions, but· also their ·expected future actions, and trade-offs between

 4            what they choose to do today versus what they may receive in the future.

 5            This more realistic setting leads to another common problem or incentive

 6             conflict between manager8 and principals: these parties having differing

 7            time horizons. Typically, managers are expected to .have a shorter-term

 8            focus than otherwise would be optimal.         A'S a result of their .possibly

 9            shorter time horiwns, managers may make decisions that focus solely on

10            the short term at the expense of the long-term. Incentive compensation

11            tied to measures that look both to the short-term (such as the current

12            year's earnings) and long-term {such as stock price) is an accepted

13            solution to extend the managers' time horizons, and to balance short-term

14            and long-term perspectives, in decision-making and execution.

15

16     Q.     DOES EXTENDING THE MANAGERS' TIME HORIZONS HAVE A

17            POSITIVE EFFECT ON :EXPECTED CONSUMER WELFARE?

18.    A.     Yes. In the context of maximizing-customer welfare, the horizon of the

19            manager is an important issue. To the extent the Commission wishes to

20            maintain and ..enhance >Customer w.elfar..e not only in the short-run, but also

21            in the future, financial measures like stock price performance play a useful

22            role in' an incentive compensation structure in -0rc:ler to accomplish this

23            obj0ctive.

      '2007 T-exas Rate Case                                                1-0-15
      Entergy Gulf States, Inc.                                                     Page 14of 19
      Direct Testimony of Jay C. Hartzell
      2007 Texas Rate Case

 1                    In addition to providing incentives for managers to optimize their

 2            decisions in the current year, a financial-based incentive plan can provide

 3            this perspective by capitalizing the long-term benefits of managers'

 4            decisions. In other words, via incentives based on financial performance

 5            measures such as stock p~ce, the expected long-term impact of

 6            managers' decisions has immediate impact on financial performance

 7            measures, thereby affecting managers' pay and incentives. Stock prices

 8            are based on the present value of the firm's expected future cash flows.

 9           So, by making a manager's compensation depend on stock price, one ties

10           the manager's wealth to expected future cash flows. This makes him o~

11           her more willing to make decisions that produce long-term b~nefits for the

12           firm, even if it is at the cost of short-term cash flows or profits.

13

14    Q.     HOW DO FINANCIAL-BASED INCENTIVES EXTEND THE MANAGERS'

15           TIME HORIZONS TO THE BENEFIT OF CONSUMER WELFARE?

16   A       To see how incentive pay affects customer welfare over multiple years,

17           first take an extreme hypothetical example where managers are only

18           compensated based on this year's customer welfare. This could create an

19           incentive for the manager to make decisions that would sacrifice the future

20           of the firm (and its customers) for the benefit of the immediate welfare of

21           customers.       The manager might "over-invest" in immediate customer

22           service, weakening the firm's future financial position and its ability to

23           provide high-qu~lity, low cost service in the future; With limited resources,

     2007 Texas Rate Case                                                    10-16
       Entergy Gulf State;s, Inc.                                              Page 15of 19
       Direct Testimony of Jay C. Hartzell.
      2-007 Texas Rate-Case

 1             the firm might· decide to pay for this "-over-investment" in immediate

 2             customer service by taking money from long-term maintenance spending

 3             or capital investment that would produce long-term efficiency or

 4             productivity gains.

 5                      But, by linking a manager's pay at least· in part to the financial

 6             health of the firm, one forces the manager to think about more than just

 7             the short term, and to consider future yea.rs and the future performance of

 8             the firm when. tliey decide on a course of action. If the manager over-

 9             invested in immediate customer welfare, then it w0uld weaken the firm's

10             financial position and potentially, consumers' future welfare. Conversely,

11             by weighing not only immediate customer welfare, but also financial

12             measures like stock price that are related to the firm's short- and long-tenn

13             viability, the manager has the incentive to position the firm to provide

14             higher levels of customer welfare in the future.

15

16    Q.      WHY SHOULD · THERE                BE A POSITIVE RELATION BETWEEN

17            CUSTOMER WELFARE A.ND FINANCIAL PERFORMANCE?

18    A.      Back to the basic theory, then, financial measures should be part of the

19            manager's compensation structure if one wants to maximize customer

20            welfare so long as those financial measures are related to {or are signals

21            of) customer welfare.           This is plausible and reasonable for several

22            reasons. First, customer welfare is difficult to measure"Completely, so it is·

23            unlikely that objective customer-based measures that one -can use in a ·

     2007 T-exas Rate Case                                                 l0-17
      Entergy Gulf States, Inc.                                                 Page16of 19
      Direct Testimony of Jay C. Hartzell
           r
      2007 exas Rate Case

 1             compensation structure will fully capture _what is trying to be measured.

 2             Then, so long as the firm's financial performance is positively correlated

 3             with customer welfare, in this period or in the future, financial performance

 4             should optimally enter the compensation structure with positive weight

 5             (meaning that the manager receives greater compensation when the

 6             financial performance of the firm is greater). The accepted literature on .

 7             compensation theory is clear that less-noisy (i.e., more accurate) signals.

 8             of managers' actions are preferred over noisier.(less accurate) signals, but

 9             even noisy signals of managers' actions should be Included in the optimal

10             compensation contract. Thus, so long as a financial measure such as

11             stock price · is correlated with customer welfare (beyond what the

12             operational measures can explain), then it should enter the compensation

13             structure of the manager. The more accurate it is as a signal, the greater

14             weight (or bigger role) it should receive ..

15

16    Q.       ARE THESE FINANCIAL THEORIES SUPPORTED BY EMPIRICAL

17             EVIDENCE?

18    A.       Yes.   There are multiple empirical studies published in peer-reviewed

19             academic journals that report evidence consistent with these hypotheses.

20
21    Q.       HOW      DO     THESE        EMPIRICAL         STUDIES   SUPPORT    THESE·

22             HYPOTHESES?

     2007 Texas Rate Case                                                  10-18
      Entergy Gulf States, Inc.                                                 Page 17of19
      Direct Testimony of Jay C. Hartz-ell
      2007 Texas-Rate·-case

 1    A.      There is a we.alth of existing empirical evidence that is supportive of these

 2            theories. First, published papers have shown that customer satisfaction

 3            measures are positively correlated with firms' financial perf.ormance.     In

 4            other wor-ds, firms with higher customer satisfaction seer.es tend to have

 5            better financial performance, not worse.         This fact from the .data is

 6            consistent with the arguments. above that mor.e satisfied customers are

 7            expected      to   result in   higher profits   and   better overall fmancial

 8            performance. This finding also suggests that financial measures--can play

 9            a positive role in motivating managers to improv.e customer welfare. This

10            result of a positive relation between financial performance and customer

11            satisfaction is inconsistent with the idea that managers tend to maximiz.e

12            financial perforinance to the detriment of customers, which should help

13            alleviate some fears that contracts incorporating financial-performance

14            incentiv.es will lead managers to diminish their customers' welfar.e for the

15            sake of greater financial performance and higher compensation. Jn the

16           data, financial success tends to -be associated. with greater -customer

17           satisfaction, not iess.

18                    There is also evidence that higher .customer satisfaction scores ar.e

19           associated with higher market values acroos firms. This empirical r.esult is

20           consistent with the widely-held notion that -the stock market is a

21           mechanism by which the long-term benefrts of customer welfare are

22           capitalized into a present value measure. This result that higher customer

23           satisfaction scores are associated with higher market values has been

     2007 Texas Rate -Case                                                  W-19
        Entergy Gulf States, Inc.                                                Page 18 of.19
        Direct Testimony of Jay C. Hartzell
        2007 Texas Rate Case

   1            shown for a broad set of companies in general, and also for the utility

   2            industry in particular.

   3                    Empirical evidence also suggests that these relations between

   4            customer · satisfaction and financial performance change as customer

   5            satisfaction becomes very high. This change is consistent with the idea· ·

   6            that there are diminishing (financial) returns to improving customer

   7          . satisfaction, implying that it becomes more and more     exp~nsive   to keep

   8            improving customer satisfaction.    Such an . increasing cost of customer

   9            satisfaction is consistent with the notion discussed earlier that providing

 1O             managers with incentive compen.sation that is only based on this peri9d's

 11             customer welfare measures might lead managers to over-invest in current

 12             customer welfare to the detriment of the long-term financial health of the

 13            .firm, potentially endangering future customer welfare, as well. As also

 14            discussed earlier, including measures such as stock price in the

 15            compensation structure of managers can help provide incentives for

 16            managers to notonly·consider the immediate welfare of customers, but to

 17            also weigh future years' customer welfare and the financial health of the ·

 18            company when they make decisions while running the firm.

 19                    The evidence on firms in or near financial distress is also consistent

 20            with the opinions presented earlier that firms that are more likely to enter

 21            into financial distress are more likely to encounter significant costs of

 22            distress, which could materialize in the form of higher future costs for

· 23           customers and lower future customer welfare {compared to the <;osts that

       7JJ07 Texas Rate Case                                                10-20
          Entergy Gulf States, Inc.                                               Page 19of19
          Direct Testimony of Jay C. Hartzell
          2007 Texas Rate Case

     1           would have been realized without the firm in distress). There is evidence

 2               that firms with more debt (relative to their equity) suffer more when their

 3               industries do not do· well. Heavily indebted firms tend to invest less and

 4               lose more sales in industry downturns when compared            to their less-
 5               indebted industry counterparts, which would be expected to lead to higher

 6               average costs in industries with economies of scale, such as the utility

 7               industry. In addition, it has been shown that these firms wlth more debt

 8              ·tend to be penalized by customers and suppliers, again leading to greater

 9               costs than what one would have experienced without such distress.

10 .

11        Q.     CAN YOU          DRAW ANY CONCLUSIONS              BASED     UPON THESE

12               COMMONLY ACCEPTED ECONOMIC AND FINANCIAL PRINCIPLES?

13        A.     Yes.    These theoretical arguments are intuitive and based on sound,

14               commonly accepted economic and financial principals Thus, it is possible

15               to draw conclusions based upon the ·application of logic to fundamental

16               finance principles.        In my opinion, the existing empirical evidence is

17               supportive of the conclusion that incentive compensation structures that

H3               include financial-based performance measures tend to benefit oonsumers.

19

20        Q.     DOES THIS CONCLUDE YOUR PREHLi:D DIRECT TESTIMONY?

21        A.     Yes.

         2JXJ7 Texas Rate Case                                                10-21
This page has been intentionally left blank.

2007 Texas Rate Case                 10-22
             APPENDIX B

Direct Testimony of Jay C. Hartzell, Ph.D
         PUC Docket No. 37744
                                                        SOAH Docket No. XXX-XX-XXXX
                                                           PUC Docket No. 37744
                                                        ETI Exhibit No .. 14
                            DOCKET    NO.~
      APPLICATION OF ENTERGY            §    PUBLIC UTILITY COMMISSION
      TEXAS, INC. FOR AUTHORITY         §
      TO CHANGE RATES AND               §           OF TEXAS
      RECONCILE FUEL COSTS              §

                            DIRECT TESTIMONY

                                      OF

                           JAY C. HARTZELL, PHO.

                                  ON BEHALF OF

                           ENTERGY TEXAS, INC.

                                                   B ...-.....,~~~~::::..::::....::::
                                                   DATE:_...._-"--'-____;:::_.::_.::::::::.

                              DECEMBER 2009

2009 ETI Rate Case                                              4-357
                                 ENTERGY TEXAS, INC.
                       DIRECT TESTIMONY OF JAY C. HARTZELL, PHO.
                                    2009 RATE CASE

                                     TABLE OF CONTENTS

       I.      Background and Introduction                                              1

       II.     Overview of the Issues Surrounding Incentive Compensation               3

       Ill.    The False Dichotomy Between Compensation Tied to "Financial"
               Measures and Compensation Tied to "Operational" Measures; and
               the Benefits of Cost Control, Profitability, and Stock Price Measures   8

      IV.      Costs to Customers of Discouraging the Use of Incentive
               Compensation That is Linked to Cost Control, Profitability and
               Stock Prices                                                            18

      V.       Response to Common Arguments Against Incentive Compensation
               Linked to Cost Control, Profitability and Stock Prices from the
               Customers' Perspective                                                  23

      VI.      Empirical Evidence Supporting Testimony                                 25

      Vii.     Conclusion                                                              28

                                             EXHIBITS

      EXHIBIT JCH-1         Curriculum Vitae of Jay C. Hartzell

700Q If.TI Rate Case                                                      4-358
      Entergy Texas, Inc.                                                        Page 1of28
      Direct Testimony of Jay C. Hartzell, PhD.
      2009 Rate Case

 1                         I.      BACKGROUND AND INTRODUCTION

 2    Q.      PLEASE STATE YOUR NAME, TITLE, AND BUSINESS ADDRESS.

 3    A.      My name is Jay C. Hartzell. I am an Associate Professor of Finance at the

 4            Mccombs School of Business at the University of Texas at Austin.          My

 5            business address is Department of Finance, The University of Texas at

 6            Austin, 1 University Station B6600, Austin, Texas 78712.

 7

 8    Q.      ON WHOSE BEHALF ARE YOU TESTIFYING?

 9 A. I am testifying on behalf of Entergy Texas, Inc. ("ETI" or the "Company").

10

11    Q.      PLEASE STATE YOUR EDUCATION, PROFESSIONAL AND WORK

12            EXPERIENCE.

13 A. I obtained a Bachelor of Science degree (cum laude) from Trinity

14            University in May 1991, with majors in Business Administration and

15            Economics. After graduating, I went to work as a consultant for Hewitt

16            Associates, in The Woodlands, Texas.        Hewitt is a consulting firm that

17            specializes in benefits and compensation. While there, I specialized in the

18            area of defined contribution plans. I left Hewitt to go to graduate school at

19            the University of Texas at Austin in 1993. I completed my PhD in finance

20            there in May 1998.          Upon graduating, I took a job as an Assistant

21            Professor of Finance at New York University's Stern School of Business,

22            where I worked until 2001. At that time, the University of Texas at Austin

23            hired me as an Assistant Professor at the Mccombs School of Business

2009 ETI Rate Case                                                       4-359
      Entergy Texas, Inc.                                                        Page 2 of 28
      Direct Testimony of Jay C. Hartzell, PhD.
      2009 Rate Case

 1            ("Mccombs School"), where I have worked since. I was promoted to the

 2            rank of Associate Professor (with tenure), effective in the fall 2006.

 3            Beginning in the fall of 2008, I was given the title of Allied Bancshares

 4            Centennial Fellow. I also now serve as the Executive Director of the Real

 5            Estate Finance and Investment Center at the McCombs School.                My

 6            current curriculum vitae is attached as Exhibit JCH-1.

 7

 8    Q.      HAVE YOU PREVIOUSLY TESTIFIED BEFORE A REGULATORY

 9            COMMISSION?

10    A.      Yes. I have submitted written testimony on incentive compensation issues

11            and testified on behalf of the Company before the Public Utility

12            Commission of Texas ("Commission" or "PUCT") in PUCT Docket No.

13            34800, and on behalf of Entergy Louisiana, LLC before the Louisiana

14            Public Service Commission on incentive compensation issues in Docket

15            No. U-20925. I have also submitted written testimony on behalf of Entergy

16            Arkansas, Inc. before the Arkansas Public Service Commission on

17            incentive compensation issues in Docket No. 09-084-U.

18

19    Q.      WHAT IS THE PURPOSE OF YOUR TESTIMONY?

20    A.      The purpose of my testimony is to discuss the extent to which incentive

21            compensation - including compensation based on dollar-based measures

22            such as cost control, profitability, and stock prices - is linked to and

23            benefits customers' interests for companies such as ETI.

2009 F.Tl Rate Case                                                      4-360
      Entergy Texas, Inc.                                                       Page 3 of 28
      Direct Testimony of Jay C. Hartzell, PhD.
      2009 Rate Case

 1            II.     OVERVIEW OF THE ISSUES SURROUNDING INCENTIVE
 2                                 COMPENSATION

 3    Q.      WHAT FORMS OF INCENTIVE COMPENSATION DO YOU FOCUS ON

 4            IN YOUR TESTIMONY?

 5   A        The focus of my testimony is on incentive compensation that is linked to

 6            cost control measures (for operating costs and capital expenditures),

 7            profitability measures (including earnings and operating cash flow), and

 8            stock prices. Compensation that is linked to these sorts of measures - for

 9            companies generally and for ETI in particular - include annual incentive

10            plans, long-term incentive plans, restricted stock grants, and stock option

11            grants. The compensation could come in the form of cash (as in annual

12            incentive plans), stock or stock-based units (as in ETl's long-term

13            incentive plan, or "L TIP"), or options.

14

15   Q.       WHAT IS YOUR UNDERSTANDING OF HOW COMPENSATION BASED

16            ON COST CONTROLS, PROFITABILITY AND STOCK PRICES HAS

17            BEEN CHARACTERIZED IN RECENT PUCT RATE DECISIONS?

18   A        In such cases, compensation that is linked to cost controls, profitability

19            and stock prices as discussed in the previous question has commonly

20            been referred to as incentive compensation that is based on "financial

21            measures."       This category of incentives has been distinguished from

22            incentive compensation that is based on measures that are not

23            denominated in dollars, such as customer satisfaction, reliability, and

2009 ETI Rate Case                                                      4-361
     Entergy Texas, Inc.                                                               Page 4 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1           safety metrics, which has commonly been categorized as incentive

 2           compensation based on "operational measures." As I discuss later in my

 3           testimony, I view this as a false dichotomy for the purposes of assessing

 4           whether     customers       benefit   from   a   particular   form   of     incentive

 5           compensation.

 6

 7   Q       WHY DO FIRMS USE INCENTIVE COMPENSATION IN GENERAL, AND

 8           COMPENSATION BASED ON COST CONTROLS, PROFITABILITY AND

 9           STOCK PRICES MORE SPECIFICALLY?

10 A. Incentive compensation is a prevalent tool used to attract, motivate, and

11           retain the qualified and talented employees needed to ensure that a

12           business can continue to operate successfully. To understand why it is so

13           widely used, it is first useful to draw a distinction between the level and

14           form of compensation. The level of compensation can be thought of as

15           the total dollar value of compensation received by an employee from all

16           sources, including salary, cash incentive-based pay, the value of

17           long-term incentives such as stock performance units and options granted

18           (albeit typically applicable to a much smaller group of employees), and the

19           value of benefits.       In order to attract and retain employees, this level

20           needs to be in line with the labor market for a particular type of employee,

21           whether it is an engineer, a maintenance worker, or a chief executive

22           officer.   Otherwise, all things equal, that same employee will take a job

23           with a company that is offering the more attractive level of pay and

                                                                             4-362
      Entergy Texas, Inc.                                                           Page 5 of 28
      Direct Testimony of Jay C. Hartzell, PhD.
      2009 Rate Case

 1            benefits.     Company witness Kevin G. Gardner discusses the overall

 2            reasonableness of ETl's level of compensation in his direct testimony.

 3

 4    Q.      HOW DOES THE FORM OF COMPENSATION DIFFER FROM THE

 5            LEVEL OF COMPENSATION?

 6    A.      The form of compensation can be thought of as the split of total

 7            compensation across these components - for example, how much is paid

 8            via salary versus annual incentive-based compensation. Holding the total

 9            level of compensation fixed at the proper market level, the form of

10            compensation is important because it can help motivate employees to

11            engage in behaviors that positively impact the operational efficiency of the

12            firm, or positively affect its cost structure. At the same time, the form of

13            compensation is important to attract and retain certain types of employees

14            that offer a skill set or a particular talent that is important to the company's

15            operations.     For example, if a compensation plan provides for incentive

16            payments if goals are met - such as controlling costs at some level - then

17            according to basic economic theory, employees will be motivate.,d to work

18            harder toward those goals. More subtly, such incentive pay will tend to

19            attract and retain employees who believe that they are especially good at

20            controlling costs because they will expect higher compensation under

21           such a plan. This implies that a firm seeking to manage costs will find it

22           valuable to institute such an incentive compensation plan as part of the

2009 ETI Rate Case                                                          4-363
     Entergy Texas, Inc.                                                         Page 6 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1           design of the form of compensation, while keeping the level of

 2           compensation at a competitive market-based amount.

 3

 4   Q.      WHAT       IS   YOUR       UNDERSTANDING         OF   THE   COMMISSION'S

 5           PREVIOUS VIEW ON ALLOWING THE RECOVERY OF INCENTIVE

 6           COMPENSATION EXPENSE THROUGH RATES?

 7   A.      My understanding of the Commission's recent rulings on this issue is that

 8           the Commission has distinguished between compensation tied to what it

 9           has termed operational measures and compensation tied to what it has

10           termed financial measures. Generally, the Commission has not allowed

11           for the recovery of incentive compensation tied to financial measures

12           through rates, but has allowed for the recovery of incentive compensation

13           tied to operational measures. The core rationale for this distinction has

14           been that it has not been sufficiently demonstrated that incentive

15           compensation linked to financial measures is in the public interest or of

16           direct benefit to customers.        The decisions in those previous cases,

17           however, do not reflect a review or consideration of the relevant literature

18           or other matters I discuss below, all of which support a conclusion that

19           allowing utilities to use incentive pay based on cost control, profitability,

20           and stock prices is properly viewed as in the public interest and is

21           expected to be of direct benefit to customers.

2009 ETI Rate Case                                                       4-364
     Entergy Texas, Inc.                                                                   Page 7 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1    Q.     HOW WOULD YOU SUMMARIZE YOUR OPINION ON THE ISSUE OF

 2           WHETHER          INCENTIVE           COMPENSATION            BASED         ON      COST

 3           CONTROLS,          PROFITABILITY,         AND     STOCK           PRICES      BENEFITS

 4           CUSTOMERS?

 5 A. In my opinion, a well-designed compensation plan that includes incentive

 6           compensation tied to cost controls, profitability, and stock prices would

 7           tend to provide greater benefit to customers than an otherwise similar

 8           compensation plan that did not include any such incentive compensation.

 9           I discuss the details below, but the overarching basis for my opinion is as

10           stated above: incentive compensation based on cost control, profitability,

11           and stock prices helps companies attract, motivate, and retain talented

12           employees, and by doing so, both customers and shareholders directly

13           benefit.   Moreover, if ETl's incentive compensation were only based on

14           non-dollar-based measures such as safety and reliability, customers

15           would tend to be worse off, because such a plan would not provide

16           employees with incentives to look after the financial health of the

17           Company. The im!)ortant point is that customers and shareholders both

18           benefit from well-designed, balanced compensation plans that provide

19           employees with the appropriate level of compensation and that include

20           incentives      based   on    cost    control,   profitability,    stock     prices,   and

21           non-dollar-based measures such as reliability, safety and customer

22           satisfaction.

2009 ETI Rate Case                                                                4-365
     Entergy Texas, Inc.                                                            Page 8 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1        111.         THE FALSE DICHOTOMY BETWEEN COMPENSATION TIED TO
 2                        "FINANCIAL" MEASURES AND COMPENSATION TIED TO
 3                      "OPERATIONAL" MEASURES; AND THE BENEFITS OF COST
 4                      CONTROL, PROFITABILITY, AND STOCK PRICE MEASURES

 5   Q.          DO     YOU     AGREE      WITH    THE     OPINION     THAT         INCENTIVE

 6               COMPENSATION LINKED TO WHAT THE COMMISSION HAS TERMED

 7               "FINANCIAL MEASURES" DOES NOT PROVIDE DIRECT BENEFITS TO

 8               CUSTOMERS?

 9   A.          No.     Based on its previous rulings, the Commission appears to be

10               categorizing as "financial" all incentive performance measures that have

11               been labeled as such by the utility and that are based on dollar amounts.

12               These include not only measures such as earnings per share, but also

13               measures designed to promote cost containment. 1          In reading these

14               decisions and the debates among the parties discussed therein, much of

15               the discussion seems to take it as given that incentives linked to financial

16               (or dollar-based) measures, regardless of their specific characteristics, do

17               not benefit customers. As a result, the competing viewpoints reflected in

18               these decisions seem to address mainly whether to label particular

19               measures as operational or financial. 2

20                       Instead of focusing on whether a particular measure is dollar-based

21               or not - and therefore, whether incentives linked to that measure are

22               "financial" or "operational" based on the above dichotomy - I think it is

          For example, see PUC Docket No. 28840, PFD at 78.
     2
          For example, see PUC Docket No. 35717, PFD at 98.

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     Entergy Texas, Inc.                                                             Page 9 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1           more worthwhile to return to the primary question: whether specific

 2           incentives linked to dollar-based measures (including cost control,

 3           profitability, and stock prices) are of benefit to customers.

 4

 5   Q.      WHY      WOULD        INCENTIVE     COMPENSATION        LINKED          TO   COST

 6           CONTROL, PROFITABILITY, AND STOCK PRICE MEASURES BE OF

 7           DIRECT BENEFIT TO CUSTOMERS?

 8   A.      This is the case because these measures provide a necessary and

 9           important incentive to managers to improve service and control costs.

10           Perhaps the easiest example of a dollar-based measure that could be

11           used in an incentive compensation plan that would benefit customers

12           directly is cost containment.       As an example, consider an incentive

13           compensation plan that pays corporate managers an incentive award if

14           costs are suitably contained. On the one hand, such an incentive is likely

15           to benefit shareholders to some extent - managers who work under such

16           a compensation plan will work to control costs in order to achieve their

17           incentive compensation, and to the extent that they are successful, the

18           company will generate greater profits, benefiting shareholders.                 But

19           customers also directly benefit, because the company has lower costs,

20           and through the regulatory process, customers will ultimately pay lower

21           rates than they otherwise would have paid in the absence of such cost

22           controls.

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     Entergy Texas, Inc.                                                         Page 10 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1   Q.      WHAT IS THE ROLE OF THE REGULATORY PROCESS IN ENSURING

 2           THAT      INCENTIVES           LINKED    TO    COST    CONTROL        BENEFIT

 3           CUSTOMERS?

 4   A.      To understand the role of the regulatory process in linking cost control to

 5           customer benefit, first consider an extreme example where there is no

 6           regulatory lag and rates adjust instantaneously so that any change in a

 7           utility's costs is immediately passed through to customers. In this case, a

 8           cost-containment incentive clearly directly benefits customers and does

 9           not benefit shareholders at all because customers reap the entire benefit

10           of any cost-saving innovations. In the other extreme, if rates never adjust

11           to   changes     in   costs,    then   a cost-containment incentive     benefits

12           shareholders but not customers. Thus, the regulatory process plays the

13           critical role of sharing the gains from cost controls brought about by

14           managerial incentive compensation between customers and shareholders.

15

16   Q.      IS THIS POINT THAT CUSTOMERS BENEFIT FROM MANAGERIAL

17           EFFICIENCY A COMMONLY ACCEPTED TENANT OF UTILITY RATE

18           ECONOMICS?

19   A.      Yes.    This idea of a win-win scenario, where both shareholders and

20           customers benefit from managerial efficiency, is not new and is a core

21           idea at the heart of well-established principles of regulatory economics.

22           For example, James C. Bonbright discusses it in his seminal 1961 treatise

23           on utility economics, Principles of Public Utility Rates.    He notes that a

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     Entergy Texas, Inc.                                                         Page 11of28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1           potential drawback to regulated rates based on cost-plus-return pricing is

 2           that it could discourage managerial efficiency because the firm would earn

 3           little to no greater return after an efficiency gain because of a resultant

 4           change in rates. He goes on to say that regulatory lag can help resolve

 5           this problem, for the reasons discussed above.       From his discussion, it

 6           follows naturally that incentive compensation that links managerial

 7           compensation to cost savings would likely be of benefit to customers.

 8

 9    Q.     DO THESE PRINCIPLES APPLY TO OTHER FORMS OF INCENTIVE

10           COMPENSATION THAT ARE LINKED TO PROFITABILITY AND STOCK

11           PRICE MEASURES?

12   A.      Yes. While I think that cost containment measures are the most obvious

13           example of incentives that have in some past PUCT cases been

14           categorized as "financial" and yet directly benefit customers, these

15           principles apply to other dollar-based or financial measures as well, such

16           as incentive awards tied to corporate profitability and stock prices.

17

18    Q.     CAN YOU PLEASE FURTHER ELABORATE ON WHY CUSTOMERS

19           ARE LIKELY TO BENEFIT FROM COMPENSATION THAT IS LINKED

20           TO PROFITABILITY?

21   A.      Yes.    There is a direct link between cost containment and company

22           earnings, especially for a regulated utility. Managers with an incentive to

23           increase earnings will focus on controlling or cutting costs in a regulated

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     Entergy Texas, Inc.                                                           Page 12 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1           industry because it is more difficult to grow revenues.        Additionally, the

 2           same type of reasoning that supports a linkage between cost containment

 3           and customer benefit also applies to incentive measures that focus on

 4           containing capital expenditures. If managers can offer the same service

 5           while cutting back on capital expenditures by investing more efficiently,

 6           then shareholders benefit due to greater short-run cash flows for the

 7           company, and customers benefit through the regulatory process through

 8           lower recovery for the cost of capital due to a lower capital base.

 9

10   Q.      WHAT TYPE OF INCENTIVE COMPENSATION DO YOU INCLUDE

11           WITHIN THE CATEGORY OF COMPENSATION THAT IS LINKED TO

12           STOCK PRICES?

13   A.      This category would include         ~ost   long-term incentive plans (including

14           ETl's) that use performance units that are based on stock prices, as well

15           as stock options.

16

17   Q.      CAN     YOU      8RIEFL Y      SUMMARIZE       WHY     YOU    BELIEVE       THAT

18           COMPENSATION THAT IS LINKED TO STOCK PRICES BENEFITS

19           CUSTOMERS?

20   A.      Compensation that is linked to stock prices has several advantages for

21           customers as long as it is part of a reasonable, well-designed

22           compensation plan -          in other words, as long as the total level of

23           compensation is reasonable compared to the market for similar positions

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      Entergy Texas, Inc.                                                                Page 13 of 28
      Direct Testimony of Jay C. Hartzell, PhD.
      2009 Rate Case

 1            and the form of compensation is well qalanced across dollar-based and

 2            non-dollar-based measures.               First, compensation that is linked to stock

 3            prices helps ensure that managers will consider the financial health of the

 4            company when they make decisions, and it is in customers' interests to

 5            have the company continue to                   be financially healthy.        Second,

 6            stock-based compensation provides an incentive for managers and

 7            employees to ensure that the company operates efficiently, and via the

 8            regulatory process, lower costs result in lower rates than would otherwise

 9            occur.      Third,    stock-based          compensation    provides   a     monitoring

10            mechanism for managerial decision making and the overall quality of

11            management. Fourth, there is an interaction between these effects, as the

12            capital markets will tend to reward efficient long-term investments or

13            capital expenditures that will also lead to lower costs for customers.

14

15    Q.      DO THESE REASONS THAT COMPENSATION THAT IS LINKED TO

16            STOCK       PRICES        BENEFITS           CUSTOMERS        ALSO     APPLY        TO

17            COMPENSATION            THAT        IS    LINKED     TO   COST CONTROL AND

18            PROFITABILITY?

19 A. In general, yes.       Stock prices are driven in part by cost control and

20            profitability, so to the extent that managers have an incentive to increase

21            the stock price, they will also have an incentive to control costs and

22            increase profits and cash flows, and vice versa. Of the reasons listed in

23            the previous answer, the first two reasons - incentives to ensure that the

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     Entergy Texas, Inc.                                                            Page 14 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1           company is financially healthy and that it operates efficiently - are the

 2           ones that are most closely shared by compensation based on cost control

 3           and profitability.

 4

 5   Q.      STARTING WITH THE FIRST REASON YOU MENTIONED, WHY DOES

 6           COMPENSATION THAT IS LINKED TO PROFITABILITY AND STOCK

 7           PRICES BENEFIT CUSTOMERS BY IMPROVING A COMPANY'S

 8           FINANCIAL HEALTH?

 9 A. If compensation that is linked to profitability and stock prices gives

10           managers an incentive to increase their company's earnings, cash flows,

11           and stock price, then this will also provide them with an incentive to

12           ensure that the company remains financially healthy. Stock prices of firms

13           that are in poor financial condition - for example, that have high debt

14           relative to the value of their assets - tend to be lower, all else being equal.

15           Similarly, firms in poor financial condition tend to have lower earnings and

16           operating cash flows.         A stronger financial condition will also benefit

17           customers.      If a company maintains a financially healthy position, it will

18           tend to have a lower cost of capital that will in turn benefit customers

19           through lower rates.       For a discussion of this effect, see Chapter 15 of

20           Investment Valuation, by Aswath Damodaran. 3 In addition, the costs of

21           doing business with suppliers (of both goods and services, including labor)

     3
          ASWATH DAMODARAN, INVESTMENT VALUATION (John Wiley & Sons, 2d ed. 2002).

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      Entergy Texas, Inc.                                                       Page 15 of 28
      Direct Testimony of Jay C. Hartzell, PhD.
      2009 Rate Case

 1           will remain lower.       For example, if a company was not in a financially

 2            stable condition, suppliers would tend to demand higher prices or more

 3            onerous credit terms, resulting in higher costs that would lead to higher

 4            rates than would otherwise occur. These are often termed "indirect costs

 5           of financial distress," and are a commonly accepted concept in finance

 6           that is supported by empirical evidence as I discuss further below.

 7

 8    Q.      CAN YOU FURTHER EXPLAIN HOW INCENTIVE COMPENSATION

 9           THAT IS LINKED TO PROFITABILITY AND STOCK PRICES CAN TEND

10           TO LEAD TO LOWER COSTS FOR CUSTOMERS?

11    A.     The first step is to understand that compensation linked to profitability and

12            stock prices will provide managers with an incentive to operate efficiently

13            because, by doing so, a company's profitability (including earnings and

14           cash flow) and stock price will be higher than it would otherwise be. To

15            increase stock price, management tries to maximize the present value of a

16           company's expected cash flows by minimizing expenses and the cost of

17          . capital.   The role of incentive compensation in motivating managers to

18            minimize the cost of capital component and the associated benefits to

19           customers were discussed earlier.          A second channel provided by

20           incentive compensation that can benefit customers is the incentive to

21           maximize the company's cash flows.            In a regulated environment,

22           particularly one in which promotion of sales growth is discouraged, it is

23           likely to be more difficult to increase cash flows or profits by growing

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     Entergy Texas, Inc.                                                             Page 16 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1           revenues, so management will tend to focus on efficient operations and

 2           investment.

 3                   These lower costs will benefit shareholders in the short run, but

 4           customers over the long run. This is due to the regulatory process that

 5           directly links operating costs to rates. In fact, it is my understanding that

 6           the Formula Rate Plan proposed in this case provides for an even more

 7           direct link between cost savings and rates due to the frequency of reviews

 8           and reflection of any identified cost savings in customer rates.                This

 9           channel is similar to the discussion earlier as to why incentive

10           compensation that is based on cost controls will tend to benefit customers.

11

12   Q.      HOW DOES COMPENSATION THAT IS LINKED TO STOCK PRICES

13           BENEFIT CUSTOMERS VIA THE MONITORING OF MANAGERIAL

14           DECISIONS?

15   A.      One of the functions of the stock market and its various participants is to

16           monitor companies' management. In their efforts to properly value stocks,

17           analysts,      portfolio   managers,   and   traders   follow   companies        and

18           continually assess the various decisions, announcements, and pieces of

19           information they produce. In doing so, they act as a monitoring device,

20           ensuring that poor decisions would be punished by a falling stock price, so

21           managers have incentives to invest the shareholders' financial resources

22           efficiently.    In this manner, managers help keep customers' costs lower

23           than they might otherwise be in the absence of such monitoring, and

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     Entergy Texas, Inc.                                                                   Page 17 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1             improve the overall quality of service. An example of such evidence, cited

 2             in one study, shows that institutional investors can help ensure that

 3             management does not act myopically to cut research and development

 4             expenditures in order to meet short-term earnings targets. 4

 5

 6    Q.       HOW DO THESE INVESTMENT AND COST EFFECTS INTERACT DUE

 7             TO THE STOCK MARKET?

 8   A.       An     important role for stock-based compensation is to encourage

 9             managers to refrain from sacrificing long-run success in pursuit of

10             short-term profit. 5    Stock prices are based not just on a company's

11             performance in the current year, but also on the market's expectations

12             about a company's future performance over many years. This ensures

13            that good investments tend to increase stock prices, even though those

14             investments use cash today in order to produce greater cash flows in the

15            future.    This is a critical advantage of stock-based compensation over

16             annual incentive plans that are based on a particular year's (or a few

17             years') performance.        Stock-based compensation can help overcome

18             managerial myopia and provide managers with an incentive to make

19             efficient, long-term investments that benefit both customers (due to

     4
           Brian J. Bushee, The Influence of Institutional Investors on Myopic R&D Investment Behavior,
           73 THE ACCOUNTING REVIEW, 3 at 305-333 (July 1998).
     5
           For example, see M.P. Narayanan, Form of Compensation and Managerial Decision Horizon,
           31 JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS, 4 at 467-491 (1996).

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     Entergy Texas, Inc.                                                       Page 18 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1           efficient investments that lead to lower costs) and shareholders (due to

 2           higher cash flows).       In this case, the testimony of Company witnesses

 3           Joseph F. Domino and Chris E. Barrilleaux addressing the Company's

 4           expected future capital investments, and that of Company witness Robert

 5           R. Cooper regarding long-term resource planning, provide examples of

 6           such consideration.

 7

 8          IV.  COSTS TO CUSTOMERS OF DISCOURAGING THE USE OF
 9            INCENTIVE COMPENSATION THAT IS LINKED TO COST CONTROL,
10                        PROFITABILITY AND STOCK PRICES

11   Q.      WHILE YOUR EARLIER TESTIMONY DISCUSSED THE BENEFITS TO

12           CUSTOMERS OF USING INCENTIVE COMPENSATION THAT IS

13           LINKED TO COST CONTROL, PROFITABILITY AND STOCK PRICES,

14           ARE THERE ALSO NEGATIVE IMPACTS TO CUSTOMERS OF NOT

15           USING STOCK-BASED COMPENSATION?

16   A.      Yes. In my opinion customers would be adversely affected if ETI did not

17           include such incentive compensation in its overall compensation policy.

18

19   Q.      STARTING WITH AN EXTREME EXAMPLE OF A COMPENSATION

20           POLICY       WHERE       ALL        EMPLOYEES   WERE   ONLY   PAID      WITH

21           SALARIES, CAN YOU HIGHLIGHT THE IMPACT TO CUSTOMERS OF

22           SUCH A POLICY?

23   A.      Yes.    First, it is useful to note that if employees did not receive any

24           incentive compensation, salaries would have to be much higher in order to

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      Entergy Texas, Inc.                                                           Page 19 of 28
      Direct Testimony of Jay C. Hartzell, PhD.
      2009 Rate Case

 1            attract and retain the same quality of talent. Second, costs would likely

 2            rise and employee performance would likely suffer, as it would be difficult

 3            to effectively and efficiently motivate employees to take actions that would

 4            benefit shareholders and customers. In my opinion, customers would be

 5            worse off under such a policy.       This is supported by the principle that

 6            individuals respond to incentives (a basic tenet of economics), and by

 7            empirical work that shows workers' output responds to the institution of an

 8            incentive plan. 6

 9

10    Q.      WOULD CUSTOMER INTERESTS BE ADVERSELY AFFECTED IF A

11            COMPANY USED SALARY AND INCENTIVES LINKED TO MEASURES

12            THAT HAVE BEEN TERMED "OPERATIONAL" ONLY?                             IN OTHER

13            WORDS, IF THEY PROVIDED SALARY AND INCENTIVES BASED ON

14            MEASURES LIKE RELIABILITY AND SAFETY, BUT NO INCENTIVES

15            BASED ON COST CONTROL, PROFITABILITY AND STOCK PRICES?

16   A.       Yes. I believe customers would be worse off under such a compensation

17            policy.   On the one hand, incentives linked to what have been termed

18            "operational" measures can improve customer welfare because the

19            company can better attract, motivate and retain talented employees.

20            Compared to the hypothetical case where a company compensates its

21            employees with salary only, by using salary and incentives linked to, for

     6
           Edward P. Lazear, Performance Pay and Productivity, 90 THE AMERICAN ECONOMIC REVIEW,
           at 1346-1361 (December 2000).

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     Entergy Texas, Inc.                                                          Page 20 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1           example, safety or reliability, the company can pay less in salary and use

 2           the associated savings to contribute to the annual incentive plans. On the

 3           other hand, such a compensation plan still has substantial problems in the

 4           context of customer benefits.

 5                   First, there is still no free lunch - employees' salaries and incentive

 6           payments linked to operational incentives would have to be larger than

 7           they otherwise would be if the firm also offered incentive compensation

 8           linked to cost control, profitability and stock prices in order for the firm to

 9           compete in the market for labor.       Second, such a compensation plan

10           would not provide any incentives for employees and managers to control

11           costs. If employees only had incentives to improve non-cash measures of

12           performance, such as safety and reliability, then they would likely

13           over-invest in these measures relative to what customers might prefer, at

14           the expense of alternative investments that would produce lower costs for

15           customers.      For example, if management only had incentives based on

16           wait times when customers called with questions or complaints (plus a

17           base salary), then they would have an incentive to hire enough staff such

18           that customers never had to wait if they called to ask a question.

19           However, if you left it up to customers, they would likely view it as

20           worthwhile to run the risk of having to wait for a little while on rare

21           occasions if it meant that their service was provided at a lower cost and

22           those cost savings were passed along to customers through the regulatory

23           process.

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     Entergy Texas, Inc.                                                          Page 21of28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1                   Third, a compensation plan consisting of salary and incentives

 2           based solely on annual measures of operational performance could likely

 3           lead to "horizon problems." By horizon problems, I mean that managers

 4           tend to have a natural tendency, absent incentives, to focus on the short

 5           run at the expense of the long run.        Stock prices by their nature are

 6           forward looking.       Taken together, a compensation plan that included

 7           incentives based on annual measures such as reliability and customer

 8           satisfaction, but not incentives based on cost controls, profitability and

 9           especially stock prices, could provide incentives for managers to maximize

10           their immediate compensation at the expense of longer-run benefits that

11           the customer could have enjoyed. 7

12                   For example, consider a manager facing a decision whether to hire

13           additional staff to answer phones in a call center (and bring down phone

14           wait times) or to invest the same amount in a capital investment to put in

15           place a new, more centralized call center that would produce significantly

16           lower costs several years in the future.     If the manager is paid purely in

17           cash compensation including an incentive payment based on current-year

18           customer satisfaction surveys (that would include phone wait times), then

19           the manager would be more likely to forgo the long-term investment

20           project and increase payroll by hiring additional employees in order to

21           maximize his or her incentive pay by implementing the short-term solution

     7
         See M.P. Narayanan, Form of Compensation and Managerial Decision Horizon, 31 JOURNAL
         OF FINANCIAL AND QUANTITATIVE ANALYSIS, 4 at 467-491 (1996).

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     Entergy Texas, Inc.                                                          Page 22 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1           today.    But, at some point, customers are better off by having slightly

 2           longer waits on the phone now but reaping the benefits of lower overall

 3           costs in the future.       A well-designed compensation plan that includes

 4           incentives linked to both customer satisfaction (in this example) and cost

 5           control, profitability and stock prices would provide incentives for the

 6           manager in this example to properly consider the benefits of such a long-

 7           term investment without sacrificing current customer satisfaction.

 8

 9   Q.      HOW DOES THE INCLUSION OF INCENTIVE COMPENSATION THAT

10           IS LINKED TO COST CONTROLS, PROFITABILITY AND STOCK

11           PRICES       HELP      AVOID        THESE   NEGATIVE   OUTCOMES             FOR

12           CUSTOMERS?

13 A. If a company adds compe11sation that is linked to cost controls,

14           profitability, and stock prices to a compensation plan that includes base

15           salary and incentives based on non-cash based measures in a reasonable

16           way, customers are likely to be better off. Such incentive compensation

17           helps a company attract, motivate, and retain talented employees and

18           gives managers a reason to focus on the long run in addition to the current

19           year's performance, costs, customer service, and the like.

20                    This focus on the longer run is evident in the design of ETl's LTIP

21           and stock option plan. For example, ETl's LTIP bases its payments in a

22           particular year on the achievement of goals over the previous three years,

23           encouraging managers to consider consistent and long-term success as

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     Entergy Texas, Inc.                                                              Page 23 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1              key objectives.    Plus, options granted vest over a three-year period,

 2              forcing managers to think about future years and how the firm will be

 3              viewed several years into the future. The stock options also have a life of

 4              ten years, which provides an additional incentive to focus on the long

 5              term. Such a focus on maximizing stock price over a ten-year period is

 6              beneficial for all stakeholders. As stock options may be awarded annually,

 7              option grants present a rolling ten-year window for those employees who

 8              receive them, reinforcing that long-term view.      Finally, the provision that

 9              requires senior managers to continue to hold stock received via exercising

1O              option grants up to a multiple of their salary further encourages longer-run

11              thinking and incentive alignment, as managers cannot exercise all their

12              options for cash and be immune to declines in the firm's financial health.

13

14         V.     RESPONSE TO COMMON ARGUMENTS AGAINST INCENTIVE
15              COMPENSATION LINKED TO COST CONTROL, PROFITABILITY AND
16                 STOCK PRICES FROM THE CUSTOMERS' PERSPECTIVE

17    Q.        HOW DO YOU RESPOND TO THE ARGUMENT THAT INCENTIVE

18              COMPENSATION           THAT      IS     LINKED     TO    COST         CONTROL,

19              PROFITABILITY, AND STOCK PRICES WILL BE DETRIMENTAL TO

20              CUSTOMERS BECAUSE IT WILL CAUSE MANAGERS TO CUT

21              CUSTOMER          SERVICE-RELATED            EXPENSES         TO      INCREASE

22              PROFITS?

23   A.         This   argument    underscores        the   importance   of   a    well-balanced

24              compensation plan.      By including both incentives based on non-dollar

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      Entergy Texas, Inc.                                                         Page 24 of 28
      Direct Testimony of Jay C. Hartzell, PhD.
      2009 Rate Case

 1             based measures such as customer service, reliability and safety, and

 2             incentives based on cost control, profitability and stock price, as does ETI,

 3             management will not want to cut one in order to increase the other, but will

 4             instead look for balanced decisions that help both.

 5

 6    Q.       IS THERE REASON TO BE CONCERNED FROM THE CUSTOMERS'

 7             PERSPECTIVE         BECAUSE          STOCK PRICES AND       PROFITS ARE

 8             DRIVEN       BY     MANY           OTHER   FACTORS    IN   ADDITION         TO

 9             CONTROLLING COSTS, OR HAVING A LOW COST OF CAPITAL?

10    A.       No. Avoiding this concern is why firms generally do not use compensation

11             plans that consist solely of stock- or profit-based incentive pay - to do so

12             would be too risky for the employees and would lead to larger overall

13             compensation expense because risk-averse individuals would demand

14             higher compensation levels in order to compensate them for bearing the

15             risk of such a hypothetical plan. This is also why stock- and profit-based

16             incentive compensation is more important at the top of the organization.

17             Senior management can more clearly see (and anticipate) the impact of

18             their actions on the firm's stock price, so stock-based compensation is a

19             more efficient compensation tool for this level of management.

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     Entergy Texas, Inc.                                                          Page 25 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1                 VI.     EMPIRICAL EVIDENCE SUPPORTING TESTIMONY

 2    Q.      ARE THE CONCEPTS IN SUPPORT OF THE CUSTOMER BENEFITS

 3            OF     INCENTIVE       COMPENSATION           SUPPORTED     BY      EMPIRICAL

 4            EVIDENCE?

 5   A.       Yes.       As I discuss below, there are multiple studies published in

 6            peer-reviewed journals that report evidence that is consistent with my

 7            testimony.

 8

 9   Q.       IS     THERE    EMPIRICAL          EVIDENCE    THAT   THE   ADOPTION         OF

10            INCENTIVE        TARGETS           BASED   ON    STOCK      OR      EARNINGS

11            PERFORMANCE BENEFITS CUSTOMERS?

12   A.       Yes. There is a published study that examines the adoption of long-term

13            incentive    plans that reward        managers with   stock or stock-based

14            compensation, where the stock grants are based on long-run profitability. 8

15            The study finds that after the adoption of such plans, managerial

16            compensation is more closely linked to the interests of managers and

17            stakeholders, including customers. This is also consistent with the studies

18            I discuss below, such as one that links market value with customer

19            satisfaction.

     8
           Alka Arora and Pervaiz Alam, CEO Compensation and Stakeholders'              Claims,
           22 CONTEMPORARY ACCOUNTING RESEARCH, 3 at 519-547 (Fall 2005).

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     Entergy Texas, Inc.                                                                  Page 26 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1   Q.       HOW DO OTHER EMPIRICAL STUDIES SUPPORT THE OPINION

 2           THAT       INCENTIVE         COMPENSATION              TIED     TO      STOCK         OR

 3            PROFITABILITY BENEFITS CUSTOMERS?

 4   A.       Earlier, I mentioned two empirical studies that provide support for my

 5           opinion that stock-based incentive compensation provides benefits to

 6           customers.      The first study provides evidence of how the oversight of

 7           companies' performance by stock-market participants can affect those

 8           firms' investment behavior and curtail managerial myopia. 9 This is one of

 9           the channels I discussed earlier by which the presence of stock-based

10            incentive compensation can benefit customers by encouraging managers

11           to focus beyond the short term and think about long-term efficient

12            investments.      The second study shows that workers do respond to

13            incentive plans in a manner consistent with the intent behind the plans'

14           design. 10 Thus, if a company adopts a compensation plan that includes

15            incentives based on customer welfare and stock price, one can expect

16            managers to take actions to improve customer welfare and maximize

17            stock price (holding all else equal).

18                    In addition, there is empirical evidence in the literature that firms

19           with higher market values tend to also have higher customer satisfaction,

20           supporting the conclusion that the goals of financial success and customer

     9
          Brian J. Bushee, The Influence of Institutional Investors on Myopic R&D Investment Behavior,
          73 THE ACCOUNTING REVIEW, 3 at 305-333 (July 1998).
     10
          Edward P. Lazear, Performance Pay and Productivity, 90 THE AMERICAN ECONOMIC REVIEW,
          at 1346-1361 (December 2000).

2009 ETI Rate Case                                                                4-384
     Entergy Texas, Inc.                                                                 Page 27 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

 1              satisfaction are interrelated. 11   This result has been shown for a broad

 2              sample of firms, but also for utilities in particular. This empirical finding is

 3              inconsistent with the idea that the most profitable or valuable firms

 4              become that way by cutting customer service, and instead suggests that

 5              there exists positive feedback between a firm's financial performance

 6              (stock price) and customers' welfare, even in the utility industry.

 7                     Empirical evidence also exists that some firms hurt their financial

 8              performance (stock price) by overinvesting in customer service. 12               This

 9              result suggests that including stock price in the compensation plan will

10              help ensure against myopic investments in short-term service that would

11              come at the expense of investments that would produce greater long-term

12              benefits to customers.     It also points toward the conclusion that basing

13              incentive compensation for purposes of setting rates solely on operational

14              goals could well be harmful to customers' interests in the long run.

15                     Finally, there is empirical evidence that firms with lower stock prices

16              (or that are less financially healthy) face higher costs and greater risks.

17              For example, some researchers have shown how less financially healthy

18              companies have trouble responding to external shocks, and face higher

19              costs of doing business (through higher wages or worse terms from

     11
          Christopher D. Ittner and David F. Larcker, Are Nonfinancial Measures Leading Indicators of
          Financial Performance? An Analysis of Customer Satisfaction, 36 JOURNAL OF ACCOUNTING
          RESEARCH, Supplement 1998 at 1 - 35.
     12   Id.

2009 ETI Rate Case                                                               4-385
     Entergy Texas, Inc.                                                           Page 28 of 28
     Direct Testimony of Jay C. Hartzell, PhD.
     2009 Rate Case

1            suppliers, for example ). 13 These results support yet another channel by

2            which stock-based incentive compensation should provide direct benefits

3            to      customers.      Stock-based    incentive   compensation       encourages

4            managers to maintain a company's financial health, thus leading to more

5            efficient operations and greater cost control than would otherwise occur.

6

7                                       VII.     CONCLUSION

8    Q.      DOES THIS CONCLUDE YOUR DIRECT TESTIMONY?

9    A.      Yes, at this time.

     13
          Chris Parsons and Sheridan Titman, Capital Structure and Corporate Strategy (January
          2007). The article is available at titto://ssrn.com/abstract=983553.

2009 ETI Rate Case                                                         4-386
                    APPENDIX C

Redacted Direct Testimony of Sarah J. Goodfriend, Ph.D
                PUC Docket No. 28840
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                 SOAH DOCKET NO. XXX-XX-XXXX             zao~ FEB          -9 PH 2: 21
                    PUC DOCKET NO. 28840              PUBLIC UTfLIT y COMMISSION
                                                                    FILING CLERK
APPLICATION OF AEP TEXAS      §       BEFORE THE STATE OFFICE
CENTRAL COMPANY FOR           §                 OF
AUTHORITY TO CHANGE RATES     §       ADMINISTRATIVE HEARINGS

                         REDACTED

                     DIRECT TESTIMONY

                             OF

                 SARAH J. GOODFRIEND, PH.D.

                       ON BEHALF OF

        CITIES SERVED BY AEP TEXAS CENTRAL COMPANY

                                              CERI'IFIED TO B£ A 'T'RUE AND CORRECT
                                              COPY OF THE ORIGINAL ON FILE WITH THE
                                              PUBLIC lfl'ILITY COMMISSION OF TEXAS
                                              CENTRAL RECO · DIVISION

                                              BY:':.....liµ.u..::e:::it'...4,L...t:::;.~:C:::!!::"'(

                                              DATE:_........_..'-..L.:...-A~I=::'

                      FEBRUARY 9, 2004
 1             I.     INTRODUCTION AND ORGANIZATION OF TESTIMONY
 2
 3   Q.    PLEASE STATE YOUR NAME AND BUSINESS ADDRESS.

 4   A.    My name is Sarah Goodfriend and my business address is 1500 West 24th Street,

 5         Austin, Texas 78703.

 6   Q.    BRIEFLY DESCRIBE YOUR EXPERIENCE AND QUALIFICATIONS

 7         RELEVANT TO THIS PROCEEDING.

 8   A.    As an economic consultant specializing in competition and regulatory policy issues, I

 9         have twenty-five years of experience in the regulated electric utility and

10         telecommunications industries. Prior to entering graduate school, I was employed as

11        an economist by the Public Utility Commission of Texas ("PUCT").                 In 1983, I

12         worked for Carolina Power And Light Company, receiving a Ph.D. in economics

13         from the University of North Carolina at Chapel Hill in 1985. Since that time, I have

14        worked and testified on behalf of the Economic Policy Office of the Federal Energy

15        Regulatory Commission and the Bureau of Economics of the Federal Trade

16        Commission. I returned to the PUCT in 1992 to create an Office of Economic Policy

17        and was appointed a PUC Commissioner in 1993, serving until 1995. Before starting

18        my        consulting   practice,   I joined   the   Washington   D.C.   office    of MCI

19        Telecommunications Corporation where I was responsible for policy development

20        and providing expert witness testimony. I have been an independent consultant since

21         1997.

22                   As an independent consultant, I provided expert testimony on behalf of South

23        Texas Electric Cooperative and a Central Power and Light Wholesale Customer

24        group in the AEP-CSW merger proceedings. Since then, as my resume shows, I have

     DIRECT TESTIMONY                              6                                  GOODFRIEND
           remained active as an advisor or testifying witness on behalf of various market

 2         participants in the electric utility and telecommunications industries. Most recently, I

 3         have worked as an advisor to a group of Retail Electric Providers ("REPs") pursuant

 4         to their participation in the Texas Nodal Team stakeholder meetings. Some of these

 5         REPs are active in the TCC service tenitory.

 6   Q.    ON WHOSE BEHALF ARE YOU PROVIDING THIS TESTIMONY?

 7 A. I have been retained by Cities served by AEP Texas Central Company ("Cities").

 8         AEP Texas Central Company ("TCC") is the monopoly TDSP for these Cities in their

 9         role as market participants, end-use customers and ratepayers.

10   Q.    WHAT IS THE PURPOSE OF YOUR TESTIMONY?

11   A.    Cities desire that the rates and operations of TCC not hinder the development of a

12        competitive market.     Cities' experience with the deregulated market has not been

13        good. I have been asked to identify cross-subsidies, anti-competitive behavior and

14        areas where improvements to quality of service can be made. My testimony evaluates

15        TCC's (1) quality of service to retail customers, (2) request for good cause exception

16        Subst. R. §25.342(f)(D), (3) proposed discretionary service fees and (4) request for

17        pre-approval for recovery of REP bad debt expense.

18        A.      PRINCIPAL FINDINGS AND RECOMMENDATIONS

19   Q.   WHAT ARE YOUR PRINCIPAL FINDINGS?

20   A.   My testimony reaches these principal findings:

21         1.     The quality of service that TCC is providing to REPs, end-use customers and

22        the market is unacceptable and contrary to provisions of the Public Utility Regulatory

23        Act ("PURA").

     DIRECT TESTIMONY                           7                                    GOODFRIEND
 1         2.      The structure of TCC costs supports difficult to detect cross-subsidy of

 2         wholesale operations by using and placing retail ratepayer dollars at risk.

 3         3.      TCC's request for a good cause exception to the PUCT's Electric Business

 4         Separation Subst.     R.   § 25 .342(f)(D) Other Service would permit greater

 5         circumvention of the PUCT's Unbundling Rules than now exists.

 6         4.      Transmission Construction Services and Associated Business Development

 7         ("ABD") Operation and Maintenance ("O&M") Services are the two categories of

 8         service that TCC offers pursuant to the Other Service exception. Neither class of

 9         service complies with the requirements of Subst. R. § 25.342(f)(D)(i).

10         5.      TCC's Transmission Construction Service is principally supplied using

11         personnel non-essential to T&D system operations. To avoid future cross-subsidies,

12         TCC's best course of action is to create a stand-alone Constrnction Services operation

13         separate from the regulated utility business.

14         6.      TCC's non-compliance with requirements of Subst. R. § 25.342(f)(D) Other

15         service is consistent with evidence of high Administrative and General expense but

16         declining staffing/resources for retail operations that Dr. Patton finds and is also a

17         likely reason for the poor service quality for regulated retail operations that Dr. Patton

18         and I find.

19         7.      Various changes need to be made to TCC's proposed Discretionary Service

20         Tariff fees, terms and conditions to improve service quality and better align TCC's

21         tariff offerings with market needs.

22         8.      TCC's request for pre-approval for deferral and inclusion of any REP bad debt

23         expense is premature and contrary to policy.

     DIRECT TESTIMONY                            8                                     GOODFRIEND
     Q.      WHAT ARE YOUR PRINCIPAL RECOMMENDATIONS?

 2 A. I recommend the Commission:

 3            1.      Adopt a rate of return recommendation consistent with the requirements of

 4           PURA Sec.36.052 to recognize the poor quality of services TCC now provides.

 5           2.       Direct TCC to return to the lower level of estimated meter readings it reported

 6            for each customer class prior to the inception of the retail Choice Pilot project.

 7           3.       Deny      TCC's     request     for   a    good     cause     waiver     of    Subst.    R.

 8           § 25.342(f)(D)(ii)(III) Other services. Thus, The Commission should direct TCC to

 9           apply the $2,542,584.341 profit TCC has failed to record as a revenue credit in this

10           proceeding to reduce the total revenue requirement in this case. 2

11           4.       Immediately place a moratorium on TCC's acceptance of new Transmission

12           Construction contracts.         The moratorium should not be lifted until (a) TCC

13           demonstrates compliance with Subst. R. §25.342(f)(D) Other service, or, as a

14           preferred alternative, (b) separates Transmission Construction Services completely

15           from unregulated utility operations in ERCOT.

16           5.       Immediately place a moratorium on TCC's acceptance of new ABD O&M

17           contracts until (a) TCC demonstrates compliance with Subst. R§ 25.342(f)(D) Other

18           Service and (b) TCC implements the REP-survey recommendations listed below.

19           6.       Direct TCC to implement the following changes to its Discretionary Service

20           tariff fees, terms and conditions:

     I Profit from Updated Response to Cities 17-14, provided in Workpapers.

     2 Response to Staff BA 1-5. Margins received from third-party contracts for transmission services were booked
     to FERC Account No. 417-Revenues from Non-utility operations.

     DIRECT TESTIMONY                                   9                                           GOODFRIEND
 1                     a) 6.1.2.1.8 Inaccessible Meter Fee should remain a Denial of Access to

 2                         Meter Fee. TCC should retain responsibility to document, upon request,

 3                         customer denial of access.

 4                     b) 6.1.2.1.6 Special Meter Reading Fee should not be charged when a REP

 5                         requests an actual meter re~d on an outstanding bill with estimated usage.

 6                     c) An Account History Fee should not be charged to end-users, REPs or

 7                         aggregators of record. 3

 8                    d) 6.1.2.1.13 Copying Fee, 6.1.2.15 Special Products/Service Fee or other fee

 9                         may not be charged as a substitute for the Account History Fee.

10                    e) 6.1.2.1.16 Special Billing Services Fee, 6.1.2.1.13 Copy Fee or 6.1.2.15

11                         Special Products/Service Fee shall not be charged to REPs or aggregators

12                         requesting a Detailed Billing and Invoicing Analysis.

13                    f) TCC's terms and conditions are not in compliance with Consumer

14                         Protection Rules as proposed. TCC should be directed to conform its tariff

15                         to the rule adopted in Docket No. 27084.

16           7.       Deny TCC's request to defer any bad debt expense incurred in providing

17           service to REPs and deny TCC's request for grant of authority in this rate proceeding

18           to include such costs in TCC's next base rate case.

19           8.       Direct TCC to file as non-confidential the "B Report" portion of TCC's

20           Quarterly Performance Report that ERCOT now files confidentially on behalf of

21           TCC.

     3 The Account History Fee does not appear in the tariff as a proposed or existing discretionary service and so
     has no tariff reference number.

     DIRECT TESTIMONY                                   10                                         GOODFRIEND
     Q.       PLEASE PROVIDE THE LIST OF REP-SURVEY RECOMMENDATIONS

 2            YOU REFER TO IN YOUR FIFTH RECOMMENDATION ABOVE.

 3   A.       The list is:

 4            •   Increase dedicated resources and reorganize job responsibilities so each REP has

 5                a dedicated REP relations person. (Now there is one person "dedicated" to all

 6                REPs).

 7           •    Create and apply job performance metrics to reward job performance relating to

 8                REP satisfaction.

 9           •    At no charge, prepare a Detailed Billing and Invoicing Analysis for different

10                classes of meters and services for each REP or aggregator that requests it.4

11           •    Schedule and offer at least one face-to-face meeting between REPs and their

12                customer service representatives annually.

13           •    Provide current usage information to aggregators upon request for all active

14                premise locations ("ESI-IDs") that have provided a letter of authorization for their

15                usage information to be released to the aggregator.

16           •    Annually perform an anonymous Customer Satisfaction Survey for REPs and

17                aggregators.5

18           •    Provide Commission staff with a software and staffing improvement plan

19                identifying timetables, targets and budgets for Customer Service business and

     4 Alternatively, TCC should produce a manual of information necessary for the REP/aggregator to perform
     detailed analysis. A Detailed Billing and Invoicing Analysis includes the breakout and definition of each
     charge type which underlies any composite charge provided, so that the bill or invoice may be readily
     understood and interpreted.
     5 The survey should be modeled on the anonymous telephone survey now being performed by CenterPoint
     TDSP for REPs. Perform this survey until granted waiver of this requirement by the Commission. File the
     results publicly with the Commission.

     DIRECT TESTIMONY                                 11                                      GOODFRIEND
 1                    related Information Technology operations to improve TCC's performance with

 2                    protocols and other measures of quality of service discussed here.

 3   Q.         HOW        ARE     YOUR       RECOMMENDATIONS              RELATED         TO   YOUR

 4              FINDINGS?

 5   A.         My recommendations lay out what is necessary for the PUCT to do in this proceeding

 6              to (1) gain control over the unnecessary costs that TCC is imposing on the ERCOT

 7              market by providing poor service quality at retail and (2) eliminate the cross-subsidies

 8              of wholesale operations that TCC is providing from retail ratepayers.

 9              B.       ORGANIZATION OF TESTIMONY

10   Q.         HOW IS YOUR TESTIMONY ORGANIZED?

11   A.         This concludes Section I, Principal Findings and Recommendations. In Section II, I

12              evaluate the Customer Service TCC provides to the retail market.            Section III

13              addresses TCC's request for good cause exception to §25.342(f)(D)(ii)(III) and

14              includes compliance issues related to TCC's provision of unregulated wholesale

15              service. Section IV addresses TCC's proposed discretionary service fees and Section

16              V addresses TCC's request for certain treatment of REP bad debt expense.            The

17              testimony concludes with support for rate case expenses in Section VI.

18        II.   CUSTOMER SERVICE PROVIDED BY TCC TO THE RETAIL MARKET

19   Q.         WHAT ARE YOUR FINDINGS?

20   A.         (1)    AEP has unnecessarily imposed significant costs on the market, on market

21              participants, and thereby, on the quality of service the market delivers to end use

22              customers.

     DIRECT TESTIMONY                                 12                                   GOODFRIEND
 1         (2) AEP lacks concern for TCC's retail customers. This lack of concern results in

 2         missed opportunities to improve market performance at little or no cost to TCC.

 3         (3) AEP management understaffs and undersupports TCC customer service functions

 4         necessary for market development and for the delivery of acceptable service quality

 5         to end users.

 6         ( 4) Without regulatory action in this proceeding, TCC will continue to provide a case

 7         study in how TDSP interests fail to align with market needs.

 8         A.     STANDARDOFEVALUATION

 9                1.       DESCRIPTION OF UNNECESSARY COSTS

10   Q.    WHAT DO YOU MEAN BY "UNNECESSARY COSTS"?

11   A.   Unnecessary costs are costs imposed when a TDSP fails to perform acceptably in all

12        dimensions of service: (1) quality and timeliness of communication, (2) speed of

13        response, (3) pro-active problem solving, (4) dedication of resources and (5) accuracy

14        of response. When any one of these dimensions of service deteriorates, the customer

15        begins to experience unnecessary costs of doing business. Said differently, a TDSP

16        that is able to excel in these performance areas is contributing to minimizing the costs

17        of doing business in the market, and probably minimizing its own long-term costs of

18        providing customer service as well. End-use customers are the ultimate beneficiaries

19         when a TDSP is performing acceptably in all dimensions of service, thereby avoiding

20         unnecessary costs to market participants and consumers.

     DIRECT TESTIMONY                          13                                   GOODFRIEND
 1   Q.    HOW ARE END-USE CUSTOMERS HARMED BY UNNECESSARY COSTS?

 2   A.    Customers are harmed in three ways:

 3         First, a customer suffers directly from unnecessary delay and inaccuracy. A delayed

 4         bill means the customer cannot budget or exercise control over electricity costs.

 5         Second, customers are harmed by prices higher than they need to be. And, third,

 6         customers are harmed because it is not rational for REPs to market, develop a

 7         reputation or differentiate their products on the basis of service quality.

 8   Q.    WHY ARE PRICES HIGHER THAN THEY NEED TO BE?

 9   A.   There are two paths by which prices to end-use customers increase.              Economists

10        understand that in competitive markets, any increase in a suppliers' cost of doing

11        business must ultimately lead to a price increase. Unnecessary costs increase the

12        REP's cost of doing business. Because REPs must ultimately pass along service costs

13         imposed by an inefficient TDSP to end use customers, these unnecessary costs can be

14        thought of as an implicit or hidden tax on REPs, and ultimately on end-use customers.

15   Q.   WHAT IS THE SECOND PATH TO HIGHER PRICES?

16   A.   By raising all REPs' cost structures, unnecessary costs operate as an implicit

17        reduction in headroom.        This understanding is why the Commission has been

18        concerned since before the onset of Customer Choice with "headroom".                  The

19        reduction in headroom is the second path whereby unnecessary costs result in a price

20         increase to end users. A reduction in headroom can limit entry or force market exit of

21         otherwise worthy suppliers. In tum, this tends to raise prices to end-users by limiting

22        the size, number or extent of diversity among suppliers.

     DIRECT TESTIMONY                            14                                      GOODFRIEND
 1   Q.    WHAT IS THE PROBLEM CREATED FOR RETAIL SERVICE QUALITY?

 2   A.    With Customer Choice, REPs have become the closest link to customers for

 3         enrollment, billing, and customer care services. Yet, the quality of service the REP

 4         can provide can be no better than what the REP receives upstream from ERCOT or

 5         the monopoly TDSPs. Thus, it makes no sense for REPs interested in differentiating

 6         their service from their peers on the basis of superior service quality to invest in

 7         resources that would allow them to do so, until risks associated with TDSP service

 8         quality are controllable. This important dimension of REP competition cannot take

 9         root without reliably acceptable upstream service quality from TDSPs and ERCOT.

10                2.      PURA STANDARDS: WHEN UNNECESSARY                                COSTS
11                        BECOME UNACCEPTABLE COSTS
12
13   Q.    WHAT PURA STANDARDS ARE INSTRUCTIVE FOR AN ASSESSMENT

14         OF RETAIL SERVICE QUALITY?

15   A.   First, PURA provides some qualitative standards for assessing service quality. For

16        example, Sec. 38.022 recognizes that an electric utility may not engage in a practice

17         that tends to restrict or impair competition. As just discussed, poor TDSP service

18         quality is such a practice in the context of an emerging competitive market.

19                Second, within the Customer Safeguards for Retail Competition section,

20        (PURA Sec. 39.101), the Commission must establish customer protection standards

21        that entitle customers to, among other things, bills presented in a clear format and in

22         language understandable by customers; accuracy of metering and billing; and other

23         information or protections necessary to ensure high-quality service to customers. The

24        customer is also entitled to prompt resolution of disputes with its chosen REP and

25        TDSP.

     DIRECT TESTIMONY                           15                                  GOODFRIEND
                  PURA recognizes the tendency of suppliers to deteriorate service quality as a

 2         method of cost-cutting and so provides for the assessment of civil and administrative

 3         penalties to enforce customer safeguards.

 4   Q.    DOES PURA PROVIDE OTHER STANDARDS?

 5   A.    Yes, PURA prohibits service from deteriorating relative to standards established

 6         under integrated utility operation. PURA directs the PUCT to modify its current

 7         customer protection rules on or before June 30, 2001 "to ensure at least the same level

 8         of customer protection against potential abuses and the same quality of service that

 9         exists on December 31, 1999 is maintained in a restructured electric industry."

10         (PURA Sec. 39.lOl(f)).

11                Finally, PURA provides for a timely enforcement action and the exercise of

12         some "incentive regulation," in that PURA requires the PUCT to consider quality of

13         service when setting the rate ofreturn. (PURA Sec. 36.052).

14                3.      PURA/ECONOMIC             FRAMEWORK:           THE      ALIGNMENT
15                        STANDARD
16
17   Q.    ARE YOU OFFERING AN ECONOMIC FRAMEWORK FOR ANALYSIS

18        THAT YOU DERIVE FROM PURA'S STATUTORY STANDARDS?

19   A.    Yes, I am. There is a simple way to understand how service quality provided by

20        TDSPs can deteriorate relative to the integrated utility world of December 1999.

21   Q.    PLEASE EXPLAIN.

22 A. In the integrated utility/captive customer model, "the market" consisted of captive

23        customers, and captive customers or their representatives accessed the regulatory

24        process to provide effective feedback on utility operations. This regulatory model

25         encouraged the private incentives of utility management concerning quality of service

     DIRECT TESTIMONY                          16                                   GOODFRIEND
           to be, depending on specifics of management and regulation, more or less aligned

 2         with the interests of end-use customers (or at least aligned with regulatory perceptions

 3         of end-user requirements).

 4   Q.    HOW SO?

 5   A.    Regulation could create incentives for the utility to align its expenditure pattern with

 6         customer service requirements. In rate proceedings, regulators set prices and imposed

 7         service standards. This kind of regulation provided readily available ways for end-

 8         use customers or their representatives to access the regulatory process and express

 9        dissatisfaction with rates, services, service offerings (rate design) and service quality.

10        Considering the total dollars at risk in generation, transmission and distribution

11        combined, utility efforts to respond to customers and manage customer relations were

12        a necessary asset-preservation investment strategy. Absent effective regulation, there

13        was no need to consider regulatory feedback effects on its balance sheet when making

14        cost/quality decisions.

15   Q.   HOW HAVE THINGS CHANGED?

16   A.   A new problem introduced by Customer Choice is one of "incentive alignment" for

17        the remaining regulated utility, the TDSP. One of the purposes of regulation is to

18        create incentives for a utility to "internalize" important externalities, in other words,

19        to create incentives for the utility to take into account the effects of its decisions and

20        actions on costs borne by others when this "internalization" is in the public interest.

     DIRECT TESTIMONY                           17                                    GOODFRIEND
 1   Q.       ARE YOU SAYING THAT AEP ISN'T PROVIDING TCC WITH ENOUGH

 2            RESOURCES DEDICATED TO RETAIL CUSTOMER SERVICE QUALITY?

 3   A.       Yes, and I am saying more. Although a misallocation of resources is a part of the

 4            answer, it is not the full answer.

 5   Q.       PLEASE EXPLAIN.

 6   A.       One can explain the poor quality of customer service at TCC as a consequence of

 7            cost-cutting by AEP management in response to financial pressures (such as those

 8           created by recent failed investments in unregulated businesses).6 To manage needed

 9           cash flow, AEP allows the service quality offered by the regulated business to

10           deteriorate in order to compensate for cash flow lost by unregulated operations. This

11           describes a situation of unacceptable and impermissible cross-subsidy of the

12           unregulated operations by misallocation of resources from the regulated business.

13                    Although the evidence is consistent with this view, I believe this unacceptable

14           cross-subsidy is a symptom as well as a contributing factor to problems with

15           customer service at TCC. Said differently, even if AEP were not cross-subsidizing

16           losses, due to the incentive alignment problem I describe, we would still find TCC's

17           service quality to deteriorate with the arrival ofretail choice in ERCOT.

18   Q.      WHY       AREN'T        AEP-TCC'S          INCENTIVES          TO      PROVIDE         QUALITY

19           SERVICE PROPERLY ALIGNED NOW?

20   A.      Incentives have changed because the odds have changed. Especially in the case of

21           AEP, significant assets are no longer at risk in this regulatory proceeding. AEP has

     6 See for example, the $5.8 million in trading losses that appears against Miscellaneous Income in TCC's Rate
     Filing Package, WP II-E-5. See also AEP's Annual Report for 2002.

     DIRECT TESTIMONY                                   18                                        GOODFRIEND
 1           sold or will sell ERCOT assets upstream and downstream of its TDSPs. Unlike the

 2           other TDSPs in ERCOT, AEP no longer has significant investment in affiliated REP

 3           operations whose service quality depends, at least in part, on the service quality it

 4           receives from the TDSP. Moreover, AEP is prohibited under its agreement with

 5           Centrica from entering the ERCOT market as a residential and small commercial REP

 6           until 2006.7

 7                   From a utility management perspective, generation is no longer subject to

 8           rate-of-return regulation by Texas regulators.         In ERCOT, the individual utility

 9           transmission investment decision is now subjected to an ERCOT-wide priority

10           planning process and then annual costs are socialized.                In subjecting major

11           transmission projects to ERCOT staff and stakeholder review, the ERCOT planning

12           process tends to operate like a pre-investment prudence review, reducing

13           disallowance risks (except perhaps for cost overruns) for larger transmission

14           investments. Thus, compared to the old world, the dollars at risk or exposure from

15           poor service quality are significantly reduced.        End-use customers' dissatisfaction

16           with service from the distribution utility no longer poses the potential threat to

17           revenues or profits that it once did.

18                   From an end-user perspective, finding the responsible party has become more

19           difficult and once found, the payoffs for effort are simply lower. With socialized

20           transmission costs, end-use customers of the TDSP are no longer directly responsible

21           for paying the costs of their TDSP's transmission investments. Thus, the payoff to

     7 Notice and Request for Approval of Changes in Ownership and Affiliation of Mutual Energy CPL, LP and
     Mutual Energy WTU, LP, May 22,2002 Docket No. 25957, Attachments.

     DIRECT TESTIMONY                                19                                     GOODFRIEND
 1           end~use   customers in terms of cost/bill reductions from using the regulatory process

 2           to address concerns with service quality has declined.

 3                    Moreover, the complexity and interdependence of market transactions

 4           necessary in order to provide end-user services has increased, requiring the

 5           coordinated efforts ofTDSPs, ERCOT and REPs. Not surprisingly, Customer Choice

 6           engendered unprecedented levels of electricity customer complaints. 8 If customers

 7           are unsure where responsibility lies, this complexity further reduces the pay-off to

 8           end use customers or their representatives of holding a TDSP accountable for its

 9           contribution (or lack thereof) in setting the level of service quality the market is

10           capable of providing.

11   Q.      WHAT KIND OF STANDARDS HAS THE COMMISSION SET FOR TDSPS,

12           ERCOT AND REPS ?

13   A.      The Commission has set quantitative standards for certain electronic transactions and

14           numerical and qualitative standards throughout its Customer Protection Rules.

15   Q.      WHY HAS THE COMMISSION SET QUANTITATIVE STANDARDS FOR

16           CERTAIN ELECTRONIC TRANSACTIONS?

17   A.      Essentially, the Commission has set quantitative standards for certain electronic

18           transactions in order to create accountability among parties for the success of highly

19           interdependent transactions.

     8 See Report to the 78th Texas Legislature, Scope of Competition in Electric Markets in Texas, Public Utility
     Commission of Texas, January 2003, page 106

     DIRECT TESTIMONY                                   20                                        GOODFRIEND
     Q.       PLEASE EXPLAIN.

 2   A.       ERCOT is the central registration agent for retail premises and the electronic hub for

 3            all retail electronic "enrollment" transactions. Electronic transactions are necessary

 4            for customers to change REPs, change premises, receive electric service, etc. At the

 5            beginning of the market, technical problems were affecting the ability of parties to

 6            timely "turnaround" the necessary transactions.

 7   Q.      WHAT KIND OF STANDARDS APPLY TO TDSPS?

 8   A.      Standards are established for ce11ain transactions by ERCOT Protocols.                       Some

 9           standards also appear in TDSP tariffs. For example, when ERCOT sends a TDSP a

10           notice of a switch request, the ERCOT Protocol requires the TDSP to send an

11           electronic acknowledgement of the request back to ERCOT within two business days

12           ofreceipt. TDSPs are also required to send their invoicing out to REPs within tariff-

13           established time frames.

14   Q.      WHAT ARE THE QUARTERLY PERFORMANCE REPORTS?

15   A.      Among other things, Quarterly Performance Reports provide technical information

16           about several electronic transactions. To identify how successful ERCOT, TDSPs

17           and REPs are in moving electronic transactions over their interconnected networks

18           and in completing the necessary electronic lifecycles in a timely and accurate fashion,

19           the technical report examines some of the 47 standard electronic transactions in the

20           Texas market (Texas SET) that can occur.9

     9 Developed in response to early problems in turning around electronic transactions, the Performance Measure
     Reports require that ERCOT report transaction volumes and "success rates" in completing electronic
     transactions within established Protocols. The Commission established a benchmark for success rates equal to
     98%. In other words, ERCOT, the TDSPs and REPs should strive to complete the electronic transactions that
     are their portion of the turnarounds within Protocol, 98% of the time.

     DIRECT TESTIMONY                                  21                                        GOODFRIEND
 1   Q.      DO THE QUARTERLY PERFORMANCE REPORTS PROVIDE OTHER

 2           TECHNICAL INFORMATION?

 3   A.      Yes. Due to early market problems, a shadow system of "workarounds" or "safety

 4           net" transactions came into being bypassing ERCOT and requiring the direct

 5           coordination of TDSPs and REPs.              The Quarterly Report requires some limited

 6           reporting by TDSPs and REPs on these manual/electronic transactions and on inter-

 7           company invoicing. I will be referencing some of this data later in my testimony.

 8   Q.      WHAT OTHER STANDARDS WILL YOU BE REFERENCING?

 9   A.      The PUCT has promulgated specific standards within its Consumer Protection rules.

10           A reading of these rules suggests that the qualitative standards I have suggested above

11           describe the essential elements that together can make or break service quality. IO

12   Q.      HOW DO THESE FIVE DIMENSIONS OF SERVICE QUALITY RELATE

13           TO THE ALIGNMENT STANDARD FROM ECONOMIC THEORY?

14   A.      Deficiencies in any one of these will impose unnecessary costs on the market.

15   Q.      HOW DID YOU DECIDE TO PROCEED?

16   A.      In order to investigate the quality of service provided to REPs, I decided to survey

17           REPs active in the TCC service area regarding service quality.

     IO These are: (1) Quality and Timeliness of Communication, (2) Speed of Response, (3) Pro-active Problem
     solving, (4) Dedication of Resources and (5) Accuracy of Response.

     DIRECT TESTIMONY                                22                                       GOODFRIEND
 1            B.       SURVEY DESCRIPTION AND RESULTS

 2                     1.          INTRODUCTION AND ORGANIZATION

 3   Q.      HAS AEP-TCC SURVEYED REPS REGARDING THEIR EVALUATION OF

 4           TCC SERVICE QUALITY?

 5   A.      No.

 6   Q.      HAVE OTHER AEP TDSPS IN STATES WITH RETAIL CHOICE

 7           SURVEYED REPS REGARDING THEIR EVALUATION OF TDSP SERVICE

 8           QUALITY?

 9   A.      No. There has been no survey. I I Moreover, there is no incentive structure in place at

10           AEP or TCC to reward employees according to REP perceptions of service quality.12

11   Q.      HA VE ANY OTHER ERCOT TDSPS SURVEYED SERVICE QUALITY?

12   A.      Within the last month, I understand that an anonymous telephone survey by a market

13           research firm is being conducted on behalf of CenterPoint, the TDSP in the Reliant

14           service te1Titory. To my knowledge this is CenterPoint's first formal survey of its

15           REP customers. ERCOT also has announced plans for its first customer survey.13

16   Q.      HOW DID YOU PROCEED?

17   A.      To investigate TCC service quality, I created and sent a REP Customer Satisfaction

18           Survey to all REPs active in the TCC service territory. I surveyed four areas of

19           importance to REP service quality: (1) Responsiveness to REP inquiries, (2)

20           Educational programming and outreach to REPs, (3) Responsiveness in resolving

     11 Response to Cities 2-97.
     12 Response to Cities 2-96.
     13 Ercot Report to RMS, 1/14/04.

     DIRECT TESTIMONY                            23                                   GOODFRIEND
 1         market problems generally, and (4) specifically, with respect to FasTrak issues. The

 2         survey and cover letter is provided as Exhibit SJG-1.

 3   Q.    HOW IS THIS SECTION OF YOUR SERVICE QUALITY TESTIMONY

 4         ORGANIZED?

 5   A.    First, I will introduce the survey.    Second, I will report the numerical results of

 6         responses on relative and absolute rankings of TCC. Third, I will review each of the

 7         four topic areas for which I solicited comments. For ease of exposition, I will not be

 8         discussing all the survey responses. However, I have included them all in matrix

 9         form within the body of my testimony.       I will be discussing some representative

10        responses that appear in the matrix.

11   Q.    DID YOU EVALU ATE THE RESPONSES YOU RECEIVED'?

12   A.    Yes. Research and discovery permitted me to directly evaluate some of the REP

13        responses to the Customer Satisfaction Survey.           I have supplemented the REP

14         responses with additional examples or illustrations related to assessing unnecessary

15         costs imposed on the market by TCC's service quality failures.

16   Q.    WHY WAS THERE A NEED FOR AN ANONYMOUS SURVEY?

17   A.   Because of the day-to-day working relationship with TCC, and fear of possible

18         retaliation, REPs suggested the need for anonymous survey response.         Even so,

19        several REPs I contacted indicated that they would not be responding due to

20        confidentiality concerns.

21   Q.   DO YOU BELIEVE FEAR OF RETALIATION rs RATIONAL?

22   A.   Yes. REPs depend upon the cooperation of TDSP personnel. It is rational to fear

23         forms of retaliation such as assigning a new employee to work an critical issue for a

     DIRECT TESTIMONY                            24                                GOODFRIEND
           particular REP, working orders from one REP before another, responding to emails or

 2         phone calls more promptly, etc. that discriminate but are difficult to detect.

 3   Q.    ARE THERE SOME OTHER REPS YOU DID NOT EXPECT TO

 4         PARTICIPATE?

 5   A.    Yes, based on economic self-interest it seemed less likely that I would receive

 6         responses from REPs affiliated with AEP or REPs affiliated with other TDSPs.

 7   Q.    HOW LARGE THEN WAS YOUR POTENTIAL POOL OF RESPONDENTS?

 8   A.    These considerations leave 26 or 27 REPs as potential respondents. Roughly l/3 of

 9         these potential respondents completed and returned the survey. The respondent group

10         of REPs included those who had been in the market from the beginning and those

11         entered later; REPs serving Residential, Commercial and Industrial customers (or

12         some combination thereof), and REPs with different market shares and distributions

13        of overall market share in AEP.

14                 2.      NUMERICAL RESULTS

15   Q.   YOU SAID EARLIER THAT YOU WOULD BE PROVIDING DIRECT

16        QUOTES FROM THE SURVEY IN ITALICS AS REPRESENTATIVE OF

17        YOUR          FINDINGS     FOR      EACH       AREA.         DO      YOU      HAVE   A

18         REPRESENTATIVE RESPONSE FOR THIS SECTION?

19   A.   Yes. It all comes down to communication and responsiveness. Resource constraints

20        may play a role but CenterPoint and Oncor find themselves well in front of AEP and

21         TNMP.        The relative ranking of AEP-TCC is consistent with the individual

22        respondent's statement .

     DIRECT TESTIMONY                           25                                    GOODFRIEND
     Q.      HOW DID YOU PROCEED IN THIS AREA?

 2   A.      For each of the four survey areas (responsiveness to inquiries, education and

 3           outreach, resolving market problems and FasTrak), I requested that respondents

 4           provide a relative ranking of the four ERCOT TDSPs, from 1 (best) to 4 (worst). For

 5           the four survey areas combined, respondents provided 30 relative rankings for AEP-

 6           TCC.

 7           The distribution of these ranks is represented by the following chart.

 8

                                 Figure 1: Relative Rank of TCC
                                          Among ERCOT TDSPs
              8
                         •Inquiries                        7      7
       Q)
       (/)    7          mResolve Fas Trak
      c:                 ~   Educ & Outreach
      0       6
      c.
      (/)
                      D Resolve Problems
       Q)
      a::     5
      .._
       0      4
       >i
      (J
      cQ)     3
       ::s
       CT     2
      Q)
      ....                   1
      u.      1
                     0           0   0
              0
                             Best              2nd             3rd               Worst
 9

10   Q.      PLEASE DESCRIBE THE CHART.

11   A.      The relative rankings are clustered at number 3, with a few outliers. The chart may

12           be read as indicating that for the Inquiries responses, indicated by solid black, 7

13           respondents gave TCC a 3rd, while 1 respondent gave AEP a 2nd and the other gave

14           AEP a 4th or Worst. For Education and Outreach, indicated by the diagonal stripe, 7

     DIRECT TESTIMONY                                26                               GOODFRIEND
 1         respondents gave AEP a 3rd and 1 respondent gave TCC a 4th. That one respondent

 2         did not rank TCC on the question is indicated by a "O." (The "O"s indicate non-

 3         responses). While AEP does best on FasTrak, notice that there were only 6 responses

 4         indicated by the hatch marks of 4 giving AEP a 3rd, 1 giving TCC a 2nd and 1 giving

 5         TCC a 1. Some respondents indicated that they had not initiated FasTrak issues with

 6         TCC. Others indicated they had little experience with TCC in this area. TCC fairs

 7        worst on resolving market problems. While it is tempting to discuss the outliers, it

 8        would be a mistake to give them too much attention, since some variation in opinion

 9        is to be expected and the sample is small.

10   Q.   DID YOU ALSO PROVIDE RESPONDENTS AN OPPORTUNITY TO

11        GRADETCC?

12   A.   Yes.   For each survey area, I requested that respondents provide a grade with

13         A=excellent, B==good, C=fair, D=poor, and F=fail.            The resulting frequency

14        distribution shows more variation in this small sample than the one above.           This

15        results express differences in the graders' standards as well as differences of opinion.

16   Q.   DO YOU HAVE A REPRESENTATIVE RESPONSE FOR THIS RANKING?

17   A.   Yes. Management needs to make customer service a priority.

18   Q.   DO REP RESPONSES SHOW A DIVERSITY IN STANDARDS?

19   A.   Yes. Those REPs that want to use service quality as a competitive distinction will be

20        sensitive to TDSP service quality, since their ability to distinguish themselves

21        depends upon the TDSP's service quality. REPs competing on the basis of price are

22        less sensitive to service quality issues (as long as other REPs are getting the same

     DIRECT TESTIMONY                          27                                    GOODFRIEND
 1              level of service quality that they do). The distribution of REP grades is provided in

 2              the following chart:

 3

 4

                                  Figure 2: TCC Grade Distribution
                                                   from REP Survey
                12-r-~-;::================================:::::-~-,
                             •Inquiries &'1 Educ & Outreach EiiJ Resolve Problems   D Resolve Fas Trak

           ~
          Ill
          c:     6
          0
          Q.
          Ill
          Q)     4
          a::
          0 2 -
          'ft
                 0 ......___ _ _ __

                      A Excellent        BGood               C Fair            D Poor              F Fail
                                                 Grades for Performance

 5   Q.         WHAT IS TCC'S GRADE POINT AVERAGE?

 6   A.         Using 4.0 for A, 1.0 for D and 0 for F, TCC's overall grade point is 1.834.

 7   Q.         WHAT ARE YOUR COMMENTS ON THIS CHART?

 8   A.         Although the numerical results are interesting, they lack the consistency that appears

 9              across the repeated written responses. The frequency distributions that result visually

1O              from the ranking exercises provide infonnation about where most responses lie

11              (central tendency) but also report some inconsistencies that exist in the responses.

12              The qualitative responses are much more uniform.

     DIRECT TESTIMONY                                      28                                               GOODFRIEND
     Q.    HOW IS THE PUCT STANDARD THAT YOU RECOMMEND RELATED TO

 2         THESE REP STANDARDS?

 3   A.    The PUCT standard is more stringent because the PUCT has the responsibility of

 4         evaluating service quality in light of all market costs, costs to REPs, to the market, to

 5         the competitive process and to end-users.

 6   Q.    IF YOU WERE GRADING TCC, WHAT GRADE WOULD YOU GIVE TCC?

 7   A.    Applying the standard I urge the Commission to adopt, and based on the evidence I

 8         will present, I would give TCC a grade of unacceptable, a Dor an F.

 9                3.      QUALITATIVE RESULTS

10   Q.    HOW WILL YOU PROCEED IN THIS SECTION?

11   A.    This section is divided into four subsections for each of the four survey areas. The

12         survey asked REPs for comment on TCC practice, and on best practices, whether

13        AEP-TCC could achieve best practice and, if so, how. For each survey area, I created

14        tables to catalogue all the narrative responses I received. There are three table rows.

15        The rows are: (1) TCC Practice, (2) Best Practice Standards/Suggestions for

16        Improvement and (3) Issue Subject to Further Analysis and/or Testimony

17        Recommendations for this area. Comments are further classified by the columns of

18        the table.   Table columns identify the dimension of service quality to which the

19        comment most pertains.        These service quality dimensions, which have been

20        discussed above, are: Quality and Timeliness of Communication, Speed of Response,

21        Pro-Active Problem Solving, Dedication of Resources, and Accuracy of Response.

     DIRECT TESTIMONY                           29                                    GOODFRIEND
 1                       LACK OF RESPONSIVENESS TO REP INQUIRIES

 2   Q.    WHAT ARE YOUR GENERAL FINDINGS IN THIS AREA?

 3   A.    REPs found TCC slow to respond to inquiries and poor at maintaining

 4         communication. They had many suggestions for improvement.           A representative

 5         statement of response is the following: At the REP relations level we are rarely able

 6         to reach TCC representatives via telephone. Issue resolution usually takes between

 7        2-4 weeks when we are able to reach a representative via phone. Issue resolution,

 8        when communicated via email, usually takes 4-6 weeks. We attribute many of these

 9        problems to lack of resources. We have one contact who handles all issues, from ES!

10        ID questions to tariff questions.     This contact is the only contact for many other

11        REPs.

12                In contrast, REPs report that other TDSPs had a habit of maintaining

13        communication regardless of whether there was an outstanding issue or not. Other

14         TDSPs routinely send back data within 2 days without follow up contact.          The

15        following table summarizes results.

     DIRECT TESTIMONY                           30                                GOODFRIEND
                                                     Dimensions of Service Quality
        Figure 3
                       Quality and                            Speed of                Pro·      Dedication               Accuracy
    Responsiveness     Timeliness of                          Response                active    of                       of
    to REP Inquiries   Communication                                                  Problem   Resources                Response
                                                                                      Solving

                       At the REP relations level we          TCC is slow in                    TCC has relatively
    TCC Practice        are rarely able to reach TCC          responding to                     limited account
                       representatives via                    historical usage                  management
                       telephone. Issue resolution            requests. For                     resources available
                       usually takes between 2-4              example, in a                     to REPs to handle
                       weeks when we are able to              [redacted] letter of              inquiries outside the
                       reach a representative via             authorization was                 scope of day to day
                       phone. Issue resolution, when          sent to TCC with                  operational issues.
                       communicated via email,                multiple ESI IDs.                 Responses to
                       usually takes 4-6 weeks. We            TCC was contacted                 business practices
                       attribute many of these                [redacted] times                  and policies, tariffs,
                       problems to lack of                    and has not                       etc. are often
                       resources. We have one                 responded. Often                  delayed if one or
                       contact who handles all                have to follow up on              more contacts are
                       issues, from ESI ID questions          usage requests and                unavailable.
                       to tariff questions. This              resend LOAs
                       contact is the only contact for        multiple times to get             From our
                       many other REPs.                       usage data back                   experiences, the
                                                                                                poor
                                                              We do not have a                  responsiveness is
                                                              lot of ESl-IDs in the             not due to
                                                              AEP territory so we               performance, but
                                                              do not need a lot of              due to resource
                                                              help. However,                    constraints on the
                                                              when we have                      Customer Relations
                                                              needed responses                  Rep.
                                                              to issues timing has
                                                              been slow.
                                                              Improvement in the
                                                              supplying of
                                                              historical data when
                                                              requested with an
                                                              LOA is needed.
2

    DIRECT TESTIMONY                                     31                                             GOODFRIEND
                                                         Dimensions of Service Quality
     figure 3 (cont.):
                          Quality and                         Speed of              Pro·             Dedication             Accuracy
     Responsiveness       Timeliness of                       Response              active           of                     of
     to REP Inquiries     Communication                                             Problem          Resources              Response
                                                                                    Solving
                          Other TDSPs were and are in     We generally              Need: Annual     Need: a designated
     Best Practice        constant contact with our       receive responses         meetings to      point of contact ••
     Standards/           REP, not just in cases of       from other TDSPs          "get to know"    name and personal
                          problem or transaction          in 2 days.                the company      email. Someone to
     Suggestions for      resolution.                                               and individual   develop a working
     Improvement                                              Other TDSPs:          REP relations    relationship with.
                          Other Customer Relations            Routinely send        managers.        Also, [need]
                          Reps make it a point to             back data within 2                     knowledgeable
                          communicate on a weekly or          days without follow   OtherTDSPs       support Reps who
                          biweekly basis to ensure            up contact.           have:            have escalation
                          customer care.                                            Redundancy of    support if they need
                                                          Other TDSPs: Very         transaction      it.
                          Go out and meet the REPs        fast response to          procedures
                          they represent and make it a    requests.                 (i.e.,
                          policy to answer all emails.                              workarounds
                                                          Need: Quicken             through email,
                                                          response times to         fax and
                                                          requests for              telephone)
                                                          historical
                                                          information. (2
                                                          REPsl
 2
 3          NO EDUCATIONAL PROGRAMMING AND OUTREACH TO REPS
 4
 5   Q.    WHAT WERE YOUR FINDINGS?

 6   A.    The strong consensus of opinion in the numerical rankings on this aspect of TCC

 7         service is confinned in what REPs had to say on this issue. Four respondents were

 8         unaware of any educational or outreach program. Another commented that TCC has

 9         never hosted any informational workshops for REPs. This respondent continued: No

10         proactive measures have been taken to inform REPs of TCC's business practices

11         regarding customer enrollment, billing, service order processing or issue resolution.

12         When attempting to obtain answers to these types of day to day operational questions

13         answers are at times inconsistent and the appropriate personnel are difficult to

14         contact.

     DIRECT TESTIMONY                                    32                                                 GOODFRIEND
     Q.    WHAT UNNECESSARY SERVICE COSTS ARE CREATED BY THIS

 2         FAILURE TO COMMUNICATE?

 3   A.    Labor costs associated with manual interventions and reparative software costs. The

 4         REP responded:       rec provides   very little outreach to help educate REPs.    For

 5         example,    rec altered the format of usage data responses.   We had no advance notice

 6         of the change. Our systems are configured to automatically upload usage data. The

 7         change in format did not work with our systems. This caused operational problems

 8         until we recognized the change and were able to alter our systems.          This REP

 9         contrasted TCC with Oncor, reporting that Oncor also altered its format for usage

10        data responses but provided ample advance notice and an example of the new format.

11        This advance notice pennitted system changes and the avoidance of operational

12         problems.

13   Q.    WHAT IS YOUR OBSERVATION ABOUT THESE COMMENTS?

14   A.   TCC's poor ranking on education and outreach show a lack of interest not a lack of

15        resources. This is not a situation where TCC must incur significant costs to support

16        market development.        This is simply a lack of pro-active customer focus.     For

17        example, a comment was:         Holding workshops and proactive communication are

18        attainable goals for AEP; There is no clear reason why TCC should not be able to

19        host such workshops for REPs. This should not only improve the operating efficiency

20        of REPs but that of TCC as well.

     DIRECT TESTIMONY                           33                                  GOODFRIEND
1   Q.      HAVE YOU PROVIDED SPECIFIC RECOMMENDATIONS RESULTING

2           FROM YOUR ANALYSIS OF THIS CUSTOMER SERVICE ISSUE?

3   A.      Yes.   These recommendations are included in summary at the beginning of my

4           testimony.

5
6

                                               Dimensions of Service Quality
          figure 4:
      Educational             Quality and                        Pro-active                       Dedication of
     Programming             Timeliness of                    Problem Solving                      Resources
     and Outreach           Communication

                                                             To date, TCC has never hosted
                           Three REPs: To respondent's       any informational workshops for
         TCC Practice      knowledge, no education or        REPs. No pro-active measures
                           outreach provided.                have been taken to inform
                                                             REPs of TCC's business
                           We are not aware of any           practices regarding customer
                           educational programs offered by   enrollment, billing, service order
                           TCC. However, we have             processing or issue resolution.
                           received email                    When attempting to obtain
                           updates/correspondence            answers to these types of day
                           regarding TCC processes.          to day operational questions
                                                             answers are at times
                                                             inconsistent and the
                                                             appropriate personnel are
                                                             difficult to contact.

                                                             TCC provides very little
                                                             outreach to help educate REPs.
                                                             For example, TCC altered the
                                                             format of usage data
                                                             responses. We had no advance
                                                             notice of the change. Our
                                                             systems are configured to
                                                             automatically upload usage
                                                             data. The change in format did
                                                             not work with our systems. This
                                                             caused operational problems
                                                             until we recognized the change
                                                             and were able to alter our
                                                             systems.

    DIRECT TESTIMONY                                  34                                              GOODFRIEND
                                              Dimensions of Service Quality
       Figure 4:
      Educational            Quality and                        Pro-active                        Dedication of
     Programming            Timeliness of                    Problem Solving                       Resources
     and Outreach          Communication

                          Three REPs: Oncor and             Invited to office and provided
      Best Practice       CenterPoint have regular          Detailed Billing Analysis
       Standards/         workshops designed to educate     notebook of all accounts.          Other TDSPs offer periodic
                          REP. This is helpful because it   Breakout and definition of each    training & seminars. Also,
     Suggestions for      keeps REPs up to date on          type and explained how to          have one specific rep relation
      Improvement         changes with the TDSPs and        interpret the bill.                person assigned
                          also allows us interaction with
                          our CSRs in person. We never      Other TDSP's meetings              Other TDSPs: (Two Reps
                          had a physical meeting with       provide: gaining a better          commented) Meetings provide
                          main contact at TCC.              understanding of internal TDSP     opportunity to meet
                                                            processes, an opportunity to       representatives face to face.
                          CenterPoint holds meetings as     address specific issues or
                          necessary to discuss procedural   concerns and an opportunity to
                          or market changes that REPs       meet and greet. We would like
                          need to know.                     to see TCC offer these
                                                            programs as well.

                                                            They[Oncor] also cover any
                                                            upcoming tarriff [sic] changes
                                                            and cover updates to their web
                                                            site.

                                                            CenterPoint holds meetings as
                                                            necessary to discuss
                                                            procedural or market changes
                                                            that REPs need to know. (Two
                                                            REPs)

2    INACCURACIES AND UNRESPONSIVENESS WORSEN MARKET PROBLEMS

3   Q.   WHAT IS THE NEXT AREA OF EVALUATION?

4   A.   The next area is how well TCC responds in resolving market problems. This subject

5        area elicited the longest and most numerous responses.                               Before presenting the

6        tabulated responses, I want to present the results of my investigation of a general, but

7        repeated allegation.

    DIRECT TESTIMONY                                  35                                                  GOODFRIEND
 1   Q.    WHAT WAS THE REPEATED REP ALLEGATION YOU INVESTIGATED?

 2   A.    A REP respondent stated: TCC is also usually the first group to complain about a

 3         change in the market and the last to get their software updated. TCC often appears

 4         to want to do just what is required and nothing more. Another REP made the same

 5         point more diplomatically, stating: AEP is generally somewhat inflexible in changing

 6         their internal practices to accommodate market concerns.

 7   Q.    IS     THIS   ALLEGATION         OF      PARTICULAR        INTEREST       IN   YOUR

 8         FRAMEWORK?

 9   A.    Yes. These allegations are another way of identifying the alignment problem. In

10         failing to accommodate market concerns, these REP statements imply that TCC is

11         imposing costs on the market that directly diminish the quality of service delivered to

12         ERCOT retail market participants.

13   Q.   WERE YOU ABLE TO FIND SOME EVIDENCE SUPPORTING THIS

14         ALLEGATION?

15   A.    Yes.    But before reviewing it, having a bit more background about electronic

16        transactions in ERCOT is helpful.

17   Q.   WILIJ YOU BE DESCRIBING THE REASON FOR MOVING FROM THE

18         CURRENT VERSION OF TEXAS SET, VERSION 1.6 TO A NEW SERIES

19        RELEASE, TEXAS SET 2.0?

20   A.   Yes. At the present time, service orders, such as requests for switching a customer's

21        REP, moving a customer either in or out of an existing premise, providing

22        connection, reconnection or disconnection, requests for changing when a meter is

23        read or for current or historical usage data, etc. all arrive to the TDSPs in

     DIRECT TESTIMONY                          36                                   GOODFRIEND
 1            chronological time. When orders arrive in chronological time but out-of-sequence for

 2            the implied cycle of transactions on a single active premise location (ESI ID), rejects

 3            occur. 47% ofrejects are caused by this type of problem.14

 4                     In these cases, the TDSPs and REPs must manually intervene and workaround

 5            the reject. These manual workarounds in tum give rise to other problems. Texas Set

 6            2.0 will solve the problem of multiple non-sequential transactions on a single ESI ID

 7            via a "parking lot" or stacking solution.                 Over the last few months, ERCOT

 8            information technology and customer service employees have been offering training

 9            seminars to acquaint market participants with these changes. The ERCOT Protocols

10            contain gray-tone provisional sections incorporating new Protocol standards once

11            Texas SET 2.0 is in place.

12                     The seminars are necessary because Texas SET is literally the standard for

13            how electronic data transactions between market participants must interface, so it is

14            mandatory that each market participants be able to fully execute Texas SET.

15            Everyone who participates in the market must update their systems with changes in

16            Texas SET. Substantial market benefits are anticipated from this major upgrade.15

17                     Finally, in the document below references to MACSS is to a customer

18            information system internal to the AEP system. References to the "parking lot" are

19            references to ERCOT's problem resolution embodied in the release of Texas Set 2.0.

     14 ERCOT, Solution to Stacking Educational Seminar, 12/9/03 available from RMS (Keydoc's) section at
     www.ercot.com.

     15 ERCOT, Solution to Stacking Educational Seminar, 12/9/03 lists expected benefits as: significant reductions
     in rejects, significant reduction in the need for Safety Net Move-ins, better manages customer expectations
     regarding dates, billing, etc, fewer backdated clean up efforts, fewer cancel/rebills, helps keep systems in synch,
     reduces unaccounted for energy, reduces transaction volume, expedites connecting and billing the customers by
     the correct REP and improves transactions reliability.

     DIRECT TESTIMONY                                     37                                           GOODFRIEND
 1   Q.    WHAT IS THE DOCUMENT YOU ARE PROVIDING BELOW?

 2   A.    Reproduced below is a Customer Choice Operations Business Case Analysis

 3         provided by TCC in discovery. This document rather perfectly illustrates my thesis:

 4         absent Commission action in this case, TCC will disregard significant market costs it

 5         imposes on others by its actions. Narrow profitability concerns are driving TCC

 6         service quality decisions. TCC has actively resisted improvements benefiting the

 7         market. The evidence corroborates the REP survey allegations I have quoted above.

 8   Q.    WHY DO YOU INCLUDE THE ENTIRE BUSINESS CASE ANALYSIS?

 9   A.   The document itself is important and the complete context of the document is an

10        important reference. The business case analysis does a good job of describing the

11        significant costs being imposed on the market by delaying the implementation of

12        Texas Set 2.0. Then, when discussing alternatives to the necessary investment the

13        analyst says: The parki11g lot will benefit the overall fu11ctio11illg of the market and will

14        benefit CRs [competitive retailers or REPs]. Due to the minimal benefit to AEP TDSP, we

15        have attempted to delay implementation through negotiation in working groups.

16                The author's use of the past tense is disturbing.

17

     DIRECT TESTIMONY                            38                                     GOODFRIEND
                                                                                            Source: Cities 10 Q 12

                 FIGURE 5: BUSINESS CASE, CUSTOMER CHOICE OPERATIONS

                                                Business Case

Business Unit: Customer Choice Operations

Project Name: CCPRIL TX Service Order Parking Lot (Texas SET 2.0)
Project ID: CHG000000724085

Start Date:               End Date:

Executive Summary: AEP is required to conform to the ERCOT Protocols as specified in Texas Standard
Electronic Transactions (SET.) Texas SET will make periodic releases to address market issues and it is
mandat01y that AEP make all changes necessary to comply. Consistent with the planned release of TX SET
2. 0, AEP will need a new application for Texas to properly sequence multiple future-dated service orders for
a single premise. The BU and IT sponsors are Jim Sorrels and Bill Vogel, respectively.

Current Situation and Problem Statement: Today, transactions are received in the order they are sent from
market participants, not necessarily in chronological order. Service orders entered into MACSS that are not
in chronological sequence cannot be completed. These out-ofsequence orders either must be manually
processed or rejected back to the CRs for resequencing. Either ofthese options requires significant manual
effort to resolve. Each TDU in Texas has this same problem and the market has decided that the appropriate
solution is for each TDU to modifY their systems to deal with out-ofsequence transactions.

Project Description: Functionality will be established to ensure that as the transactions are received by
MACSS, they will be "parked", or held, until just before the event when the specific transaction is needed (to
provide time for other orders to arrive). The transactions will then be properly sequenced to the work
management system and allowing each to complete appropriately, instead of being exceptioned for manual
processing or being rejected back to the CRs.

Solution Overview: Implementation would allow AEP to comply with TX SET and reduce the workload
associated withflXing problems resulting from out-ofsequence transactions.

Solution Detail: MACSS has estimated a delive1y cost of$106,080. There is lost opportunity costs in that
other projects that have revenue benefit will be delayed. An unquantified, but tangible benefit would be the
reduction in manual processing necessary to fix out-of sequence transactions. The risk of not implementing
these changes is that we would be in non-compliance with TX SET, with potential regulatory repercussions.

Alternatives Considered: The parking lot will benefit the overall functioning of the market and will
benefit CRs. Due to the minimal benefit to AEP TDSP, we have attempted to delay implementation
through negotiation in working groups.

Implementation Summary: The anticipated delivery date for this market requirement is May 2004, subject to
formal approval of a schedule by ERCOT.

Relationship to other Initiatives: This project is consistent with other system modifications and
enhancements required in the TX marketplace.

Metrics: Success will be measured by the successful implementation of Texas SET 2.0 and our associated
internal transaction processing. The benefits should be seen in the marketplace immediately.

    DIRECT TESTIMONY                                 39                                       GOODFRIEND
     Q.      HOW HAVE REPS CHARACTERIZED OTHER WIRES COMPANIES'

 2           PARTICIPATION IN WORKING GROUPS?

 3   A.      In describing best practices among other wires companies, one REP said:        Other

 4           Wires Companies have got a lot of active members involved in many market

 5           committees and subcommittees. These members are taking the time to improve the

 6           market place through new software, faster hardware, better logic, improved

 7           communication between REPs and more accurate market reporting.             They are

 8          proactively seeking solutions to lingering problems and trying to clear out all of the

 9           old ones.

10   Q.      BEFORE YOU LEAVE THIS TOPIC, IS THERE OTHER EVIDENCE

11           PERTINENT TO TCC'S SUPPORT OF                           MARKET WIDE SERVICE

12           IMPROVEMENTS AND COST REDUCTION EFFORTS?

13   A.      Yes. TCC lags significantly behind Oncor and CenterPoint in providing the resource

14           investment needed for Texas SET 2.0. Oncor is 95% through the design stage and

15           90% through the build stage for Texas SET 2.0. CenterPoint is 85% through the

16           design stage and 25% through build. In contrast, AEP is 20% into the design stage

17           with no build and TNMP is l 0% in the design stage with no build, according to recent

18           self-reports. 16

19   Q.      IS THERE ANOTHER CHARACTERIZATION OF TCC THAT IS ALSO

20           CAUSE FOR CONCERN?

21   A.      Yes. AEP has a history of taking unilateral action against Market Rules e.g., billing

22           customers for T&D charges who showed no REP ofRecord.

     16 The complete ERCOT presentation is provided in Workpapers.

     DIRECT TESTIMONY                                40                              GOODFRIEND
 1   Q.      WERE YOU ABLE TO INVESTIGATE THIS ALLEGATION?

 2   A.      Not definitively.     It's clear that TCC spoke with Commission staff concerning

 3           unbilled customers. In the early stages of the market there were customers for whom

 4           either the TDSP and/or ERCOT had no "REP of record. 11 TCC decided to direct bill

 5           these customers without a REP of record and it appears that in the test year, this

 6           brought in over $1.2 million to TCC. I 7          Whether TCC sent the letter first and

 7           discussed it with Staff after the fact or visa versa, I do not know. I was also unable to

 8           determine to what extent the Commission itself had an opportunity to comment on

 9           TCC's action.

10   Q.      WERE         YOU     ABLE      TO     INVESTIGATE         THIS    ALLEGATION         OF

11           UNILATERAL ACTION USING OTHER INFORMATION?

12   A.      Yes. I asked about whether TCC had ever discouraged a REP from using the FasTrak

13           process. TCC responded: In fewer than a dozen instances, TCC has asked certain

14           REPs not to utilize FasTrak for particular billing and payment issues.

15                    In the discovery response quoted, TCC reasoned that it was burdensome for

16           TCC to use FasTrak and so substituted its own databases and archives to track the

17           disputes. TCC opined that FasTrak in its present form "is not necessarily the best to

18           tool to use in the instances discussed above. 11 I 8

19   Q.      WHAT DO YOU MAKE OF THIS UNILATERAL ACTION?

20   A.      The unilateral decision to bypass market processes can impose market costs. While it

21           may be burdensome at times for market participants to use FasTrak in cases where

     17 TCC Workpaper ll-E-5 line 40 "CWRR"

     18 Response to Cities 15-3

     DIRECT TESTIMONY                                41                                 GOODFRIEND
 1           multiple premises share a common transactional problem, FasTrak is the means by

 2           which ERCOT, as the central registration agent, monitors and identifies transaction

 3           problems, trends and prioritizes needs for improvement. Once logged, FasTrak issues

 4           are never deleted. They become part of the knowledge base of historical information

 5           for each active premise and can be searched by individual ESI-ID when needed to

 6           provide background and/or resolve issues.19 Here, again TCC seems to show a basic

 7           disregard for the effects of its decisions on the market as a whole.

 8   Q.      WILL        YOU        BE      PRESENTING             OTHER          EVIDENCE           THAT

 9           CORROBORATES REP'S STATEMENTS OF CONCERN ABOUT TCC

10           PERFORMANCE?

11   A.      Yes, but first I will review specific survey findings.            Although I have tried to

12           categorize responses in this section by quality dimension, in fact, it seems that most

13           examples indicate a combination of factors are responsible for performance problems.

14           The first two examples focus on the role of inaccuracies as the source of later market

15           problems. In the instances described, inaccuq1cies impose direct costs on REPs and

16           end-use customers and may impose a second round of costs because of slow

17           responsiveness in resolving the initial inaccuracies:

18                   The first example addresses errors in TCC's data at ERCOT:

19                   TCC still has a lot of issues with inaccurate address/ESJ-ID information at

20           ERCOT. Many consumers in the TCC region are affected by un-authorized switches

21           due to incorrect information in the ERCOT portal and information TCC provides by

22          phone to the CR.

     19 See Day to Day FasTrak Issues Users Manual 10/24/2003 -Version 4.0 available from www.ercot.com.

     DIRECT TESTIMONY                                 42                                      GOODFRIEND
                  The second example shows the effects of inaccurate use of a Texas SET

 2         transaction sequence. This may also be evidence of a resource or training problem at

 3         TCC.

 4                There have been instances where a meter exchange had occurred and TCC

 5         was sending 814_20 transactions [create/maintain/retire ESI-ID request} indicating

 6        a meter removal. Then, TCC would send an 814_20 transaction indicating a meter

 7        add. Once this Texas SET error was acknowledged by TCC it still took 4 months for

 8        them to correct the problem. This incorrect use of the ESI-ID transaction caused

 9        REPs additional workload, including REPs contacting the customer via telephone to

10        question the reason for the meter removal, the submission [of] final invoices to the

11        customer and the creation of new customer accounts.

12   Q.   WHAT ABOUT BEST PRACTICE IN THESE AREAS?

13   A.   With respect to speed and accuracy, REPs responded that other wires companies:

14        provide timely and accurate connections based on 814-04/05[switch notification and

15        enrollment] transactions and safety-net/priority connections; are in synch with

16        ERCOT relating to address and ESJ-ID information; and respond to inquiries within

17        a 2-hour time frame.

     DIRECT TESTIMONY                         43                                  GOODFRIEND
       Figure 6:                                              Dimensions of Service Quality
    Responsiveness      Quality and
     in Resolving       Timeliness of            Speed of           Pro-active Problem           Dedication        Accuracy of Response
        Market         Communication             Response                Solving                of Resources
       Problems
                     It all comes down to    An isolated            AEP is generally            TCC is also       TCC still has a lot of
    TCC Practice     communication and       example of poor        somewhat inflexible         usually the       issues with inaccurate
                     responsiveness.         resolution of a        in changing their           first group to    address/ESI-ID
                     Resource constraints    market issue           internal practices to       complain          information at ERCOT.
                     may play a role but     occurred when          accommodate market          about a           Many consumers in the
                     CenterPoint and         TCC issued             concerns                    change in the     TCC region are affected
                     Oncor find              market                                             market and        by Un-authorized
                     themselves well in      transactions with      Responds well but           the last to get   switches due to inconect
                     front of AEP and        inaccurate meter       other TDSPs more            their software    information in the
                     TNMP                    data. The issue        helpful.                    updated. TCC      ERCOT portal and
                                             was identified and                                 often appears     information TCC provides
                     AEP has a history of    brought to the         We have repeatedly          to want to do     by phone to the CR.
                     taking unilateral       attention ofTCC        requested a report          just what is
                     action against          in [redacted].         from TCC regarding          required and      There have been instances
                     Market Rules e.g.,      After multiple         outstanding invoices        nothing more.     where a meter exchange
                     billing customers for   follow up phone        and TCC has failed to                         had occurred and TCC
                     T&D charges who         calls and emails       acknowledge or              All are good      was sending 814 _20
                     showed no REP of        the majority of        respond to voicemail        except for        transactions
                     Record.                 the impacted EST       or email                    TNMP. TCC         [create/maintain/retire
                                             IDs with               inquiries ... Then, after   could             ESI-ID request] indicating
                     When issues arise       inaccurate meter       months of making            probably          a meter removal. Then,
                     multiple emails must    data were finally      requests, TCC sent a        improve           TCC would send an
'                    be sent before          corrected and the      spreadsheet with            ranking with      814_20 transaction
                     answers provided.       issue was              [redacted) invoices         more staff.       indicating a meter add.
                                             resolved entirely      indicating they were                          Once this Texas SET
                                             in [redacted).         past due. Of those,                           error was acknowledged
                                             During this [7         (redacted) were                               by TCC it still took 4
                                             month period]          never received                                months for them to
                                             time, no pro-          [before] and were                             conect the problem.
                                             active measures        over 60 days old;                                 This incorrect use of
                                             were taken by          (redacted) were                               the ESI-ID transaction
                                             TCC to identify        duplicates;                                   caused REPs additional
                                             and correct the        [redacted) were                               workload, including REPs
                                             relevant ESI IDs       rejected [redacted] ...                       contacting the customer
                                             affected during                                                      via telephone to question
                                             this period.                                                         the reason for the meter
                                                                                                                  removal, the submission
                                             Unmetered                                                            [of] final invoices to the
                                             service resolution                                                   customer and the creation
                                             takes 4-6 weeks.                                                     of new customer accounts
                                                                                                                  based on the new meter
                                             Meter re-reads                                                       information.
                                             and cancel re-bills
                                             are not timely.

            DIRECT TESTIMONY                                       44                                             GOODFRIEND
                                          Many other             ..it was [only]                             TCC also does not
TCC Practice                              TDSPs send back        through our                                 perform a connection on
  (cont'd)                                IDR and non-IDR        employees research                          move-in on the dates they
                                          data much faster       that these issues were                      confirm from the 814-
                                          than TCC. The          discovered. TCC did                         04105. (For example, if
                                          IDR data is            not offer any                               the CR receives an 814-
                                          especially slow in     resources or                                04/05 from TCC with a
                                          arriving to us. A      assistance in                               connect date of 12.09.03,
                                          quicker                evaluating the                              the service may not be
                                          turnaround would       contents of the                             connected until 12.14.03
                                          be most helpful.       spreadsheet.                                or 12.15.03. Even though
                                                                                                             TCC has a safety
                                          Luckily I have not     No ESI-IDs account                          net/priority connect
                                          had a lot of           notation is made                            process, they never follow
                                          problems with          when a CR calls in,                         through when a request is
                                          TCC in quite a         so there is no history                      made.
                                          while. However,        kept on any ESI/ID.
                                          when there is a
                                          problem the
                                          response is fairly
                                          slow.

 Best Practice    Other Wires             Other wires            [TCC] management          Best practice
  Standards/      Companies : have        companies:             needs to make             is to follow
Suggestions for   got a lot of active     provide timely         customer service a        through on
 Improvement      members involved in     and accurate           priority.                 issues. Most
                  many market             connections based                                issues
                  committees and          on 814-04/05           CenterPoint and           resolved
                  subcommittees.          transactions and       Oncor both take what      easily but
                  These members are       safety-net/priority    they are given from       those that are
                  taking the time to      connections; are       the CR's and actively     more difficult
                  improve the market      in synch with          participate at WMS,       following
                  place thtough new       ERCOT relating         RMS, and Texas SET        through are
                  software, faster        to address and         to reach out and          important to
                  hardware, better        ES I-ID                assist the evolution of   customer
                  logic, improved         information.           the best in               service.
                  communication           Respond to             deregulated markets
                  between REPs and        inquiries within a     in the U.S. today.        CNP and
                  more accurate           2 hour time                                      Oncor have
                  market reporting.       frame.                 Yes, [best practice is    the better
                  They are proactively                           achievable by TCC].       capability for
                  seeking solutions to                           TCC has the ability       working
                  lingering problems                             to improve capability     around
                  and trying to clear                            for working around        market
                  out all of the old                             market problems           problems
                  ones.                                          through strnctured        through
                                                                 procedures and            structured
                  AEP TCC can be                                 contacts for              procedures
                  assured that if they                           resolution.               and contacts
                  are actively involved                                                    for resolution.
                  and listen to their
                  customers, ERCOT
                  can only evolve into
                  a better market than
                  we have now.

         DIRECT TESTIMONY                                       45                                           GOODFRIEND
 l              BILLING AND INVOICING: FOUNDATIONS FOR ERROR
 2
 3   Q.    DID YOU INVESTIGATE ISSUES RELATING TO THE ACCURACY OF

 4         BILLING AND INVOICING?

 5   A.    Yes. In this section I discuss TCC's use of estimates for meter reads and related

 6         problems of billing and invoicing. Prompt and accurate billing and invoicing are

 7         foundational issues because poor processes here can snowball into additional

 8        problems.     Any deficiencies in dedicated resources appear more severe when

 9         underlying processes or systems are prone to error. Another REP provided a good

10        example of the relationship between data inaccuracy and slow response:

11                An isolated example of poor resolution of a market issue occurred when TCC

12         issued market transactions with inaccurate meter data. The issue was identified and

13        brought to the attention of TCC in /redacted]. After multiple follow up phone calls

14        and emails the majority of the impacted ES! IDs with inaccurate meter data were

15        finally corrected and the issue was resolved entirely in [redacted]. During this [7-

16        month period} time, no pro-active measures were taken by           rec   to identifj; and

17        correct the relevant ES! IDs affected during this period.

18                Another REP noted: Meter re-reads and cancel re-bills are not timely.

19                Prompt and accurate billing and invoicing are foundational issues.         Wires

20        charges include kW and kWh charges and invoices must be cancelled and re-billed

21        when underlying usage data is incorrect. In the ERCOT protocols, a meter read error

22        gives rise to four separate electronic transactions, a cancel and rebill of the associated

23        usage data and a cancel and rebill of the associated invoice.

     DIRECT TESTIMONY                           46                                    GOODFRIEND
 1                     Moreover, timeliness and accuracy are both important service dimensions, but

 2            they are not independent. Estimated meter reads can become a source of inaccuracy.

 3            Inaccuracy can become a drag on responsiveness as the number of errors that have to

 4            be corrected increase. In tum, the volume of cancel/rebills increases and rebillings

 5            take longer to send out because the necessary corrective actions for usage information

 6            strain existing resources.

 7   Q.       DOES THE COMMISSION SET STANDARDS FOR BILLING ACCURACY?

 8   A.       No, however, Subst. R.§ 25.25 provides limits to the use of estimated bills. When

 9            questioned as to policy concerning the use of estimates versus actual meter reads,

10            TCC said that its policy concerning the use of estimated versus actual meter reads is

11            to comply with the rule.20 The rule says: An electric utility may submit estimated

12           bills for good cause provided that an actual meter reading is taken no less than every

13           third month.

14                    Further, under existing consumer protection rules, REPs must notify

15           customers if the REP is unable to issue a bill based on an actual meter reading due to

16           TDSP or other failure to timely provide actual usage and inform the customer of the

17           reason for the issuance of an estimated bill. 21

18   Q.      HOW ACCURATE ARE TCC'S ESTIMATED METER READS?

19   A.      The PUCT has no standards specifying particular methodologies for usage estimation.

20            TCC has provided documents describing the AEP estimation programs in use by TCC

21           since 1/1/2002. The estimation methods rely on simple extrapolations of historical

     20 TCC Response to Cities 15- l.
     21 See Subst. R. §25.479(e).

     DIRECT TESTIMONY                               47                                GOODFRIEND
              meter reads or historical estimates.              The estimates are not adjusted to recognize

 2            differences in weather as a factor affecting usage.22

 3   Q.       WHAT IS AEP'S VIEW?

 4   A.       AEP must agree with me that its estimation method needs improvement. In response

 5            to a discovery request provided 2/4/04, AEP provided a business case started

 6            12/04/03 titled Load Research Analysis Preliminary Plan for MACSS Bill estimation

 7            improvement. The plan includes a more statistically sophisticated approach and a

 8            weather-related adjustment for some customers. Expected completion date is May

 9           2004.23

10   Q.       ARE THERE OTHER POTENTIAL ACCURACY ISSUES ASSOCIATED

11            WITH TCC'S USE OF ESTIMATED METER READS'?

12   A.       Yes. TCC's current approach allows TCC to "dial up or dial down" its acceptable

13           level of accuracy.

14                     TCC explains that in its approach to estimation, the acceptability of estimates

15           depends on the TCC's choice of an accuracy tolerance limit. If the tolerance limit is

16           loosened, more estimates are accepted as "good." When TCC is unable to create

17           estimates that are good enough, then the account is a "no bill" for the current reading

18           date with obvious cash flow implications for TCC.24 It is not surprising that one of

19           the measures TCC tracks for customer operations functions is the level of no bill

20           accounts more than 10 days old, and that there are very, very few ofthese. 25

     22 Response to Cities 15-2, Attachment 1.
     23 Response to Cities 35-2, Attachment 1.

     24 Response to Cities 16-6.

     25 Response to Cities 30-14 attachment page 4 of 6.

     DIRECT TESTIMONY                                      48                                 GOODFRIEND
     Q.       WHAT HAPPENS IF TCC'S AUTOMATED SYSTEM TRIES TO ESTIMATE

 2            A THIRD MONTH IN A ROW?

 3   A.       PUCT rule §25.25 requires an actual meter read every third month. TCC says: If the

 4            automated system tries to estimate for a third month, then efforts are made to obtain

 5            an actual reading. This may result in manual estimation. Because the automated

 6           system will not estimate accounts with demand greater than 10 kW, all estimates for

 7           these larger accounts are manual. Except for a small pilot program using remote

 8           meter reading, all other meter readings require a premise visit. 26

 9   Q.      WHAT HAS HAPPENED TO THE VOLUME OF TCC ESTIMATED METER

10           READS SINCE CUSTOMER CHOICE?

11 A. It has exploded in all rate classes.

12   Q.      WHAT INCENTIVE ALIGNMENT PROBLEM DOES THIS SUGGEST?

13   A.      Obviously, for every estimated meter read, a premise visit may be avoided. Provided

14           data indicates the cost-savings to TCC. Using TCC's fully embedded cost estimate to

15           a REP requesting a re-read or out-of-cycle read, the savings per avoided read would

16           be about $17.00. Eliminating supervisory overheads, and usingjust direct meter read

17           avoided costs saves $5.60 on the meter reader and $1.98 on the truck.

18   Q.      WHAT DATA DO YOU HAVE TO SUPPORT YOUR STATEMENT THAT

19           THE VOLUME OF METER READS HAS EXPLODED IN ALL RATE

20           CLASSES?

21   A.      TCC provided data on the percentage of estimated meter reads by customer class

22           since January 2000, well before Customer Choice began. The data series continues

     26 Response to Cities 16-6.

     DIRECT TESTIMONY                               49                               GOODFRIEND
1            through November 2003.27 The graphic below visually demonstrates the change in

2            TCC's reliance on estimated meter reads, beginning roughly with the Pilot Program

3            for Choice.

4                      As the graphic makes clear, there has been a dramatic increase in estimated

5            meter reads, beginning roughly at the time of the Pilot Project. As could be expected

6            from this visual view of the data, the observed differences in means before and after

                                        Figure 7: Meter Reading Accuracy
                                                  Percent Estimated Meter Reads
                                                Integrated Utility vs Retail Choice
           14%   ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

                   -   • Residential
                   -commercial
      "' 12%
     "Cl
      ~
                   "   ~   Industrial
                   ---Public Au1hority
                                                                                     ''
                                                                                     '. '
                                                                                               .   ''
     ~ 10%
                                        Start of Retail Choice -
                                                              .---
                                                                           ~         '
                                                                                     ' ,,
                                                                                          ..
                                                                                     11~,--n-­

                                                                                                        '..
                                                                                                        --    -'t,.·-----   --
                                                                                                                                 ''
                                                                                                                                 -~t--

                                                                                                                                 •

                           Start of Pilot Project    --1                   : !-
                                                                           U~
                                                                           !1 I
                                                                                     ' '

                                                                      Jw  i: ~
                                                                      - __ : _v_ -
                                                                      '    ;.:1
                                                          -   .

7            the onset of choice are statistically significant for each customer class.28

8

    27 Response to Cities 15-1, Attachment 1.

    28 So as not to influence the results, I have removed the month in which Hurricane Claudette led to use of
    estimated meter readings from the data provided.

    DIRECT TESTIMONY                                                 50                                                          GOODFRIEND
 1   Q.       HOW MANY ESTIMATED METER READS DO THE PERCENTAGES

 2            DEPICTED REPRESENT?

 3   A        In discovery, TCC repo1ied a total of 594,632 automated estimated meter reads since

 4            111/02 and 55,332 manual estimates since 1/1/02. Thus, since 111/02, TCC has relied

 5            upon approximately 650,000 estimated meter reads in total.29

 6   Q.       HOW MANY ESTIMATED METER READS WERE THERE BEFORE

 7            CUSTOMER CHOICE?

 8   A        By my estimates, there would have been only about 100,000 or so estimated meter

 9            reads (through November, 2003) ifTCC had continued its pre-Choice practices.30

10   Q.       HOW MUCH HAS THE NUMBER OF ESTIMATED METER READS

11            INCREASED'!

12   A.      The number of estimated meter reads have increased by 550,000 over the 23 month

13           period since Choice began.          This indicates that at current customer levels, some

14            100,000 estimated meter reads rather than the 650,000-meter reads would have

15           occurred by now had historical norms continued.

16   Q.      HOW MUCH MONEY IS TCC SAVING THROUGH ITS CHANGED

17           PRACTICE?

18   A.      Using $5 for net avoided cost for TCC, on an annual basis the increase saves TCC

19           about $1.4 million annually. The net avoided cost approach recognizes that there will

20           be cost impacts to TCC, for example in higher levels of cancel/rebill transactions.

     29 Response to Cities 16-6.

     30 The actual calculations are provided in Workpapers. Depending on assumptions the range of baseline or pre-
     Choice estimated meter reads rnns from 83,000 to 180,000 and, correspondingly the range of increase runs from
     567,000 to 470,000 expressed cumulatively.

     DIRECT TESTIMONY                                   51                                        GOODFRIEND
             For illustration, I am assuming a net savings of $5 from TCC's decision to increase

 2           the use of estimated meter reads.

 3   Q.      WHAT ARE THE EFFECTS OF 550,000 ADDITIONAL ESTIMATED READS

 4           ON END-USE CUSTOMERS, REPS AND THE MARKET?

 5   A.      The Company provided an analysis of AEP-wide data on this topic.             The AEP

 6           analysis suggests that approximately 50% of AEP's required billing adjustments each

 7           year relate to bill estimation. For AEP, 27% of customer calls are related to high bill

 8           concerns, including estimations. Over the period January through July 2003, 4.7% of

 9           all AEP billing complaints were for inaccurate estimations.31

10   Q.      CONSIDER END-USERS. WHAT COSTS ARE IMPOSED ON END-USERS?

11   A.      First, depending on the contact option chosen, the end-use customer will need to call

12           the REP or possibly, TCC directly to inquire about the bill. The customer may feel

13           the need to escalate the inquiry into a complaint, engaging in the necessary phone

14           calls and other transactions.

15                    Second, a surprised customer is not a happy customer. REPs have indicated

16           that they must respond to customers' bill shock associated with estimated reads,

17           particularly where a seasonal rate is employed. In this context, the REP must decide

18           whether a request for re-reads is in order, and, depending on the arrangements, either

19           the REP or the customer becomes subject to the Special Meter Reading Fee.

     31 TCC Response to Cities 15-2, Attachment 1.

     DIRECT TESTIMONY                                52                               GOODFRIEND
 1                    Third, use of estimates followed by an ultimate true-up when the meter is read

 2           makes it more difficult for customers to judge savings they receive from their chosen

 3           REP. As a limiting case, the customer may feel the need to search for and switch to

 4           another REP.

 5   Q.      WHAT COSTS ARE IMPOSED ON ERCOT MARKET PARTICIPANTS?

 6   A.      The relationship between estimated meter reads and the need for cancel and rebill

 7           transactions suggests that TCC will have a higher level of cancel and rebill

 8           transactions than otherwise.      Since four transactions accompany every cancel with

 9           rebilling, these unnecessary transactions strain ERCOT resources and, where any

10           manual input is involved, potentially gives rise to errors and rejected transactions.

11   Q.      WHAT COSTS ARE IMPOSED DIRECTLY ON REPS AND THEREBY

12           INDIRECTLY ON END-USERS?

13   A.      The REP now bears the customer relations costs associated with the inquiring,

14           unhappy or complaining customer. There is also an expected cost to checking the

15           accuracy of the estimated meter read. TCC proposes to charge $17 .00 as a Special

16           Meter Reading Fee. The tariff says the REP will not be charged for a re-read if the

17           new reading indicates the original reading was in error.         So, the REP faces an

18           uncertain cost of $0 or $17. During the test year, TCC earned $385, 735 on 25,716

19           occurrences where the REP took the gamble and lost.32 Said differently, the REP

20           may have mixed incentives for following up with a re-read request on an estimated

21           bill (regardless of whether the REP or the end-use customer will pay).

     32 Response to Cities 23-4, Attachment.

     DIRECT TESTIMONY                               53                                   GOODFRIEND
                  As discussed previously, costs placed on REPs must ultimately be passed to

 2        end-use customers. Even so, the costs imposed on REPs still have an effect. They

 3        will affect the REP's perceptions of the ultimate costs of serving the customer, and

 4        thereby affect REP's pricing and service offers and possibly decisions about when or

 5        whether to enter or remain in TCC's market area.

 6   Q.   CAN YOU QUANTIFY ANY OF THE COSTS YOU'VE CONSIDERED

 7        HERE?

 8 A. I can illustrate some of the potential costs. Remember that TCC will incur some costs

 9        too. The alignment problem is that TCC considers only its net savings, in this case

10        estimated to be SS/estimated meter read, when deciding policy on the extent to use

11        estimated meter reads. My point is simply that when the potential costs to all

12        other parties are considered, if these costs exceed TCC's net $5 saving per

13        estimated meter read, TCC has made the wrong customer service decision based

14        on the alignment standard.        An illustration of costs imposed on others by the

15        change in meter reading policy toward estimated meter reads appears below: The

16        "x"s reflect the distribution of costs and the "Illustrative Unit Costs" column provides

17        hard estimates from discovery information. So, for example, the "x" across from the

18        Call Center Calls row in the end-user cost column and the REP cost column identifies

19        the fact that both of these parties may incur these kinds of costs.

     DIRECT TESTIMONY                           54                                  GOODFRIEND
 1
                                                          Figure 8
                           550, 000 Additional Estimated Meter Reads--Potential Market Costs
                                                                                   Impacted Parties
                                                                       End-User      REP     Market and PUCT
          Additional Transactions Required     Illustrative Unit Costs  Costs        Costs          Costs

            Inspect and Determine Action                           ?             x      x
            Cancel and Rebill - electronic                 l minx 40/hr = 0.66          x          x
             Cancel and Rebill - manual                    15 minx 40/hr =$10           x
                    Call Center Calls                         3.5 minx 1.00      x      x
                    Calls Forwarded                            8 minx 1.00                         x
                    Field Rep Trips                            $17 /no error     xi     ix
      High Bill Complaint Customer Service                      1hrx34/hr               x          x
             Onnortunitv Costs of Time                               ?           x
                 Higher Market Prices                              ?             x                 x
                   Bill "surprise" and
            Degradation of REP reputation                          ?             x      x          x
                      Delaved Bill                                               x      x
     "?" signifies difficult to quantify costs
     Estimates from Response to Cities 15-2 Attachment I
     And Schedule IV .J-2 11. 18
 2
 3
 4   Q.        EARLIER YOU STATED THAT HIGH LEVELS OF ESTIMATED METER

 5             READS COULD BE EXPECTED TO LEAD TO MORE CANCEL AND

6              REBILL TRANSACTIONS FOR METERS AND INVOICES.

 7   A.        Yes. The available data for TCC demonstrates this. In the data below, I have had to

 8             combine two incomplete series -- one provided in discovery and the other based on

 9             confidential and privileged information.

10   Q.        IS THE DATA ON CANCELLATIONS CONSISTENT WITH ESTIMATED

11             METER             READS            AS         ONE        REASON    FOR   THE   LEVEL      OF

12             CANCELLATIONS AND REBILLINGS?

13   A.        Yes.

14                                                  [FIGURE 9 REDACTED]

     DIRECT TESTIMONY                                              55                          GOODFRIEND
 1   Q.      HOW           MANY       CANCEL/REBILL              TRANSACTIONS               DO    THE

 2           PERCENTAGES IN FIGURE 9 REPRESENT?

 3   A.      TCC sends out about 1 million bills annually. So a [redacted] rate of cancel/rebills is

 4           [redacted I cancel/re bill transactions annually.

 5                         SLOW OR NO GO ON FASTRAK RESOLUTIONS

 6   Q.      WHAT ARE FASTRAK ISSUES AND WHY ARE THESE IMPORTANT IN

 7           DEFINING SERVICE QUALITY?

 8   A.      FasTrak is an issues-resolution system sponsored by ERCOT. FasTrak is the primary

 9           tool and entry system used by REPs and TDSPs to communicate with ERCOT

10           regarding problems with electronic customer enrollment. Problems reported through

11           FasTrak could include, for example, missing usage data or other information not in

12           the ERCOT system that is associated with a customer/premise location, rejected

13           transactions, requests for cancellation of transactions, inadvertent switches, or

14           whether or not ERCOT received a specific transaction, etc.

15                   For issues submitted to ERCOT, ERCOT will follow up with the TDSP for

16           thirty days to obtain requested transaction(s). After thirty days, the issue will be

17           reassigned as a Non-ERCOT issue, and the submitting REP and TDSP will be left to

18           continue efforts to resolve. Alternatively, some issues are initially submitted as Non-

19           ERCOT when the issue is "point-to-point" between a REP and a TDSP). No FasTrak

20           issue is deleted. Resolved or rejected issues are archived and available for search

21           purposes.33

     33 ERCOT FasTrak Day-to-Day User Manual -- Version 4.0 available from www.ercot.com.

     DIRECT TESTIMONY                               56                                      GOODFRIEND
                  REPs depend on TDSPs to take responsibility for Non-ERCOT issues and to

 2         assign sufficient resources to help resolve all FasTrak issues promptly. Resolution

 3         also requires good communication because ERCOT will not generate missing

 4         transactions when manual corrections are needed.

 5   Q.    WHAT GENERAL EXPLANATIONS DID REPS PROVIDE FOR THEIR

 6         RANKINGS OF TCC IN THIS AREA?

 7   A.   Being quick to resolve FasTrak issues is the key service quality dimension for

 8         FasTrak.   Two REPs made this point, stating that TCC was slow to respond to

 9         FasTrak issues. A customer with "very few customers in AEP territory" said: TCC is

10        generally responsive to FasTrak issues, however they rarely answer their 800-line for

11        REP support and are very slow to respond to emails and voicemails.

12                Another REP linked the slow response to lack of dedicated resources: The

13        personnel that are working FasTrak are very helpful and knowledgeable but seem

14         overwhelmed with the volume of FasTrak issues requiring their attention. [TCC

15        needs] more trained personnel.

16   Q.   DID YOU RECEIVE ANY SPECIFIC EXAMPLES?

17   A.   Yes.   A respondent commented:      TCC is generally quicker than other TDSPs to

18        acknowledge new logged FasTrak issues. However, once acknowledged, there is an

19        average resolution time of 3 weeks, with outliers up to 8 weeks. We have noted that

20         TCC is quicker to respond to logged FasTrak issues relating to enrollment and less

21        responsive to ongoing maintenance issues related to monthly meter reads and ES! ID

22         maintenance issues. Not all survey participants have logged FasTrak issues with

     DIRECT TESTIMONY                         57                                  GOODFRIEND
         TCC so some answered the survey questions with NIA. The remaining responses are

2        provided below.

        Figure 10                  Dimensions of Service Quality
    Responsiveness    Quality and
      in Resolving   Timeliness of   Speed of    Pro·    Dedication                                                    Accuracy
    f asTrak Issues Communication Response active            of                                                           of
                                                                                      Problem    Resources             Response
                                                                                      Solving

                           We have very few                      Timeliness is the              The personnel that
      TCC Practice         customers in AEP                      biggest issue with             are working FasTrak
                           territory ... AEP is generally        FasTrak                        are very helpful and
                           responsive to FasTrak                 resolution. TCC is             knowledgeable, but
                           issues, however, they rarely          slow to respond                seem overwhelmed
                           answer their 800-line for             to FasTrak issues              with the volume of
                           REP support and are very              (2 responses)                  FasTrak issues
                           slow to respond to emails                                            requiring their
                           and voicemails.                       TCC is generally               attention. Need more
                                                                 quicker than                   trained personnel.
                           Not many issues for us                other TDSPs to
                           since we have so few                  acknowledge new
                           customers in territory.               logged FasTrak
                           Issues generally resolved in          issues. However,
                           a timely, accurate matter.            once
                                                                 acknowledged,
                                                                 there is an
                                                                 average
                                                                 resolution time of
                                                                 3 weeks, with
                                                                 outliers up to 8
                                                                 weeks. We have
                                                                 noted that TCC is
                                                                 quicker to
                                                                 respond to
                                                                 logged FasTrak
                                                                 issues relating to
                                                                 enrollment and
                                                                 less responsive
                                                                 to ongoing
                                                                 maintenance
                                                                 issues related to
                                                                 monthly meter
                                                                 reads and ESI ID
                                                                 maintenance
                                                                 issues.

    DIRECT TESTIMONY                                        58                                            GOODFRIEND
                          Other TDSPs keep you well      Timeliness is key   Same day         Other TDSPs provide         (See response in
       Best Practice      informed on the status of      to resolving        response,        direct contacts and         Column 3)
        Standards/        Fas Trak issues and respond    issues on           knowledgeable    personnel
                          very quickly.                  FasTrak. Other      and well-        representatives.
      Suggestions for                                    TDSPs are           trained Reps,
       Improvement        It is much easier to call a    extremely           update           Recommended
                          CSR contact at the other       proficient in       FasTrak ticket   Action:
                          TDSPs and not get voice        processing          without having   Assignment of a
                          mail. Also, callbacks are      requests in a       to be asked,     customer
                          much faster when you do        timely manner.      notify           representative for our
                          leave a message.                                   monitoring       company.
                                                         Others often have   party by email
                                                         same day            when action      Best Practice is
                                                         resolution. They    has been         Achievable by TCC
                                                         are much quicker,   taken/ticket     [with] training and
                                                         requiring a few     updated,         operational efficiency
                                                         days or at most a   resolving
                                                         week.               action is        Yes, if their staffing is
                                                                             accurate.        adequate.

 2   Q.   DO YOU HAVE EVIDENCE CORROBORATING THAT TCC IS SLOW ON

 3        FASTRAK?

 4   A.   Yes. As indicated above, ERCOT personnel are also involved in FasTrak issues.

 5        Among the many reports that ERCOT personnel present at the monthly ERCOT

 6        Retail Market Subcommittee (RMS) meetings is a report on FasTrak activities. The

 7        most recent available evidence suggests that TCC is slow on resolving its FasTrak

 8        issues with ERCOT.

 9   Q.   PLEASE EXPLAIN.

10   A.   Here too, it is necessary to briefly discuss what is involved in making certain market

11        transactions succeed. ERCOT periodically receives from TDSPs final monthly meter

12        reads and notifications of an initial meter read on service orders that have been

13        cancelled in ERCOT service order recording systems. ERCOT recognizes various

14        types of service order cancels. ERCOT cancels service orders when it receives cancel

15        requests from the REP (perhaps due to manual or concurrent re-processing of the

16        original service order), cancel requests due to customer request, customer objection

     DIRECT TESTIMONY                                   59                                                GOODFRIEND
           (e.g., during the switch rescission period, the customer exercises the right not to

 2         switch providers), cancels due to a necessary permit not being received (e.g., on a

 3         move-in transaction where construction may be needed) or for other reasons. That

 4         the TDSP has sent ERCOT a meter read for this service order can indicate an "out-of-

 5         sync" condition in which TDSP records and ERCOT records may fail to agree on

 6         which REP is providing service.

 7                To manage these situations, ERCOT initiated a process on November 7, 2003.

 8         In this process, ERCOT initiates a weekly FasTrak issue with the appropriate TDSP

 9         as the resolving party for these transactions. ERCOT requests the TDSP to provide a

10        response either updating the FasTrak issue if the service orders are canceled in the

11        TDSP system or, if complete in the TDSP system, identify the out-of-synch condition

12        with ERCOT and initiate an effort to clear the out-of-sync conditions.

13                With respect to these November 7, 2003 cancelled service orders, the last

14        column of the second table below indicates that among the four major TDSPs TCC is

15        the only TDSP with ERCOT still waiting for responses as of the January 14, 2004

16        Report. The following figure is Figure 11.

     DIRECT TESTIMONY                         60                                   GOODFRIEND
                       TOSP         Total     12/31/03 12/19/03 '12/12103 1215/03 1'1i28i03 11/21/03 11i14103 11/l:03
          AEP                          '127       12        23       23       9        12       10       34       4
          C: ente1 P11 Int             237        16        31       20      18        34       34       67     17
          ONCOR                        287        '14     '166       1'I     14        26       32       16       8
          Sha1vl<111d                    17         2        2        2       3          3        0       2       3
          TNMP                         275        '12       94       92      21        ·17      ·17      16       6
          G1<1nd Total                 943        56      3'16      148      65        92       93      135     38

                                                                                                  Awaiting TDSP
                             TDSP               Total                nc                             Res onse
          AEP                                     127                   9                                      67
          CenterPoint                             237                 164                                        0
          ONCOR                                   287                 187                                        0
          Sharyland                                 17                    0                                      9
          TNMP                                    275                 275                                        0
          Grand Total                             943                 635                                       76

 1
 2   The full ERCOT presentation is provided in Workpapers.

3    Q.           DID REPS HAVE ANY RECOMMENDATIONS FOR TCC THAT YOU

4                 HA VE NOT INCLUDED IN SECTION I OF YOUR TESTIMONY?

 5   A.           Yes. These were generally specific requests for better performance on the service

6                 quality dimensions. REP suggestions to TCC not already captured in my specific

7                 recommendations are that TCC should:

 8   •            provide faster customer service;

9    •            respond at first request rather than requiring multiple contacts;

10   •            be more pro-active informing REPs about changes to procedures;

11   •            provide additional/more knowledgeable and qualified personnel to respond to

12                inquiries or issues;

     DIRECT TESTIMONY                                         61                                            GOODFRIEND
     •       provide additional educational programs regarding TCC's internal processes and

 2           procedures;

 3   •       provide historical usage in a user friendly format; and

 4   Ill     provide quicker turnaround on IDR and non-IDR data.

 5           C.       REBUTTAL TO TCC WITNESSES GORDON AND HOOPER

 6                    1.       ISA SERVICE QUALITY

 7                                           SUMMARY FINDING

 8   Q.      HA VE YOU REVIEWED ALL THE REPORTS FILED WITH THE PUCT

 9           PURSUANT TO TCC DUTIES TO REPORT THE CUSTOMER SERVICE

10           STANDARDS THAT TCC NEGOTIATED IN THE ISA?

11   A.      Yes, and I have done additional discovery on these matters.

12   Q.      WHAT IS YOUR OVERALL IMPRESSION OF TCC'S PERFORMANCE ON

13           ISA REQUIREMENTS?

14   A.      TCC owes fines in the form of customer credits based on inability to satisfy targets

15           that its predecessor companies had a hand in negotiating. 34 As is clear from review

16           of its required reports, TCC has not been able to demonstrate sustained or full

17           compliance with negotiated targets.         TCC's offers to fix reporting problems that

18           "explain" the non-compliance are still promises rather than realities.

     34 See Direct Testimony of Dr. A. D. Patton.

     DIRECT TESTIMONY                               62                                 GOODFRIEND
 1                                     WITNESS GORDON

 2   Q.    PLEASE         SUMMARIZE        THE      INTEGRATED         STIPULATION         AND

 3         AGREEMENT (ISA) WITH RESPECT TO CUSTOMER SERVICE (NOT

 4         RELIABILITY) ISSUES.

 5   A.    The Integrated Stipulation and Agreement was entered into by TCC's predecessor

 6         companies in May 1999. Included within the ISA in Section 7 are Customer Service

 7        Standards as well as the Reliability Standards discussed in the testimony of Cities

 8         Witness Dr. A.D. Patton. TCC Witness Gordon provides ISA Section 7 in his Exhibit

 9        HRG-4.

10   Q.   WHAT KIND OF CUSTOMER SERVICES ARE MEASURED IN THE ISA?

11   A.   The agreement provides for measurement in four areas: (1) a time-to-connect

12        standard for new service installation where no constmction is required, and (2) where

13        installation construction is required, a time-to-connect standard for (a) standard

14        facility construction and (b) a time-to-connect standard for non-standard facility

15        construction.    There is also a time-to-restore/replace standard for (3) security and

16        streetlight outages, and time-to-average-answer standard for (4) telephone response of

17        call center employees.

18   Q.   DID YOU REVIEW THE TESTIMONY ON ISA STANDARDS OF TCC

19        WITNESS GORDON?

20   A.   Yes.   Mr. Gordon describes performance in the areas of new service requiring

21        standard construction and non-standard construction and with respect to lighting

22        replacement for outages, what I have called items 2(a and b) and Item 3 above.

     DIRECT TESTIMONY                          63                                  GOODFRIEND
 1                    As Mr. Gordon shows, TCC has failed to meet target for new service

 2            involving standard construction in the third and fourth quarters of 2002 and in every

 3            quarter reported thus far for 2003.            He blames the problem on a newly initiated

 4            automated customer information system. And, he is convinced that the problem lies

 5            in the reporting system rather than performance.

 6   Q.       HAS TCC FIXED ITS REPORTING SYSTEM FOR TRACKING STANDARD

 7           CONSTRUCTION TIME-TO-CONNECT?

 8   A.      Mr. Gordon reports that problems still exist with the reporting system. Although a

 9           discovery response now asserts the reporting system has been fixed, the assertion is

10           based on the "planned implementation" of new software and order management

11           systems.35

12   Q.      DOES MR. GORDON REPORT PERFORMANCE FOR NON-STANDARD

13           CONSTRUCTION REQUESTS?

14   A.      Yes. He minimizes the failure to meet targets by explaining that there are very few

15           requests of this nature.

16   Q.      WHAT ABOUT LIGHTING REPLACEMENTS?

17   A.      Here again, TCC does not meet targets but feels that reporting problems are to blame.

18                    In response to a follow-up question, TCC explains that the order tracking

19           system identified by Mr. Gordon36 is still unable to differentiated between standard

20           and non-standard lighting replacement. A procedural change relying on functionality

     35 Response to Cities 29-13. Moreover, the discovery response suggests that, to the extent that TCC may
     subjectively evaluate "customer readiness," TCC may reset this variable thereby restarting the clock. Full
     discovery responses to Cities 29-13 are provided in Workpapers as is Response to Cities 16-21 which identifies
     the readiness requirements.

     36 Direct Testimony of Mr. Gordon at 34.

     DIRECT TESTIMONY                                   64                                         GOODFRIEND
           to be implemented should be able to report actual performance by the last quarter of

 2         2004.

 3   Q.    HOW DO YOU CHARACTERIZE PERFORMANCE ON THE TWO AREAS

 4         DISCUSSED BY MR. GORDON?

 5   A.    Like the filed reports, for each failure, the reporting incident brings with it either an

 6         excuse, a promise, or evidence of a promise unkept. These excuses and explanations

 7         also characterize Mr. Gordon's testimony.

 8                       REPORTED PERFORMANCE FOR THE ISA

 9   Q.   WHAT ARE THE REPORTING REQUIREMENTS OF THE ISA?

10   A.   The ISA imposed three annual reporting requirements: a Customer Service Survey of

11        Texas Customers and a Customer Service Report to be filed with the PUCT, and a

12        Utility Scorecard to be sent to its customers. A fourth report to the PUCT is triggered

13        by failure to meet minimum service standards for any two months within a 12-month

14        period.

15   Q.   HAS TCC BEEN ABLE TO CONSISTENTLY MEET THE TARGETS IT

16        NEGOTIATED FOR ITSELF IN THE ISA?

17   A.   No.

18   Q.   PLEASE EXPLAIN.

19   A.   First, TCC never filed all the reports contemplated by the ISA. In December 2001,

20        before any annual reports had been filed, TCC filed a petition requesting modification

21        of the standards in the ISA. By agreement with Staff, TCC was permitted to forego

22        providing the ISA-required Annual Utility Scorecard to customers. So, in February

23        2002, TCC filed 2001 data for the other two annual reports.

     DIRECT TESTIMONY                           65                                    GOODFRIEND
 1          (1)   2001 data

 2   Q.    WAS TCC IN COMPLIANCE WITH ALL ITS ISA TARGETS?

 3   A.    No, TCC was not in compliance for light replacement. TCC explained that the data

 4         was contaminated by inclusion of more complex repairs that those called for in the

 5         performance measure.     TCC opined that a system modification in January 2002

 6         would allow TCC to demonstrate better, and presumably, compliant performance.

 7   Q.    WERE THERE OTHER INCIDENTS OF NON-COMPLIANCE?

 8   A.    Yes. In April, 2001 rec notified the PUCr that it had experienced three months in a

 9         row where average speed of answer was too slow, relative to the target.         rec

10         identified the combination of extreme weather, rising gas prices and changes in the

11         volume, duration and nature of calls as causes.

12         (2)    2002 data

13   Q.    WHAT ABOUT 2002 DATA?

14   A.   TCC was out of compliance for both lighting replacement and for connection

15        requiring standard installations. In February 2003, TCC filed its 2002 data under

16         agreement with Staff that TCC provide only the same information as TCC provided

17         in 2001. Although TCC had modified its work order system in January 2002, TCC

18        was again unable to demonstrate compliance or improved lighting replacement

19        performance as predicted/ hoped for last year in TCC's explanatory comments. The

20        measure for connection requiring standard installation was also out of compliance.

21                TCC explained that the conversion from the CSW to the AEP Customer

22        Information System (known as Marketing And Customer Services System), combined

23        with workarounds necessitated by electronic exchange problems under Customer

     DIRECT TESTIMONY                          66                                 GOODFRIEND
           Choice had resulted in the need to reconstruct lost data such as construction

 2         completion dates. Thus, the reported 2002 data for connection times for standard and

 3         nonstandard installation was based on recollections of people in the field, and so, not

 4         totally accurate.

 5                                     WITNESS HOOPER

 6   Q.    WHAT MEASURES DOES WITNESS DAVID L. HOOPER DISCUSS?

 7   A.    He discusses what I have called Item 4, "time-to-average-answer standard for

 8        telephone response of call center employees." Presumably he also discusses what I

 9        have called Item the " time-to-connect standard for new service installation where no

10        construction is required."

11   Q.    WHY DO YOU SAY "PRESUMABLY"?

12   A.   Because Mr. Hooper does not report the proper measure for time-to-connect, as

13        contemplated in the ISA. I discuss this below.

14   Q.   WHAT IS THE FIRST MEASURE MR. HOOPER DISCUSSES IN HIS

15        TESTIMONY?

16   A.   The target for average speed of answer (ASA) set by the ISA is within 60 seconds.

17        As I discussed above, under certain stresses, TCC was unable to satisfy the standard,

18        and had to provide an improvement plan to the PUCT as required by the ISA.

19   Q.   WHAT ARE THE RESULTS OF THE IMPROVEMENT PLAN?

20   A.   Using the Virtual Call Center, Mr. Hooper suggests, TCC has been able to drop the

21        ASA to 38 seconds, year to date. However, since then the ASA seems to be creeping

22        up again. The updated ASA through 12/31104 is 42 seconds.

     DIRECT TESTIMONY                          67                                   GOODFRlEND
     Q.       AVERAGES ARE NICE. DOES VARIANCE MATTER?

 2   A.       Yes. As in the April 2001 event, TCC has not consistently met target in all months.

 3            Arguably it is most important to have a timely response when the system is under

 4            stress from external events that are generating the customer calls. Events in October

 5            2003 forced the monthly average above the target, suggesting that consistency of

 6            achievement on the ASA target is still in some question.37

 7   Q.      WHAT IS HIS SECOND MEASURE?

 8   A.      Mr. Hooper uses the term "existing meter" connects, and then asserts that this is what

 9            is supposed to be measured by the ISA. The ISA doesn't use this term. An "existing

10           meter" connect is a "left in hot" or energized meter.     ICC has a fully automated

11           process for connecting these meters on a move-in or switch transaction, if they have a

12           meter reading within five days prior to the requested date.38 And, we know if they

13           don't, they can complete the automated process, keeping these performance statistics

14           up, by use of an estimated meter read.

15                    The question, of course, is what happens with more difficult move-in

16           transactions. Thus, we really don't know whether ICC is meeting the 95% target

17           when the reported data is properly expanded to include all new service installations.

18           Moreover, ICC reports that it is exceeding the PUCT target of 95% in Subst.

19           R.§25.490. Subst. R. §25.490 governs the ending of the moratorium on disconnects

20           which the PUCT instituted early on to address re-connection problems. Here again,

21           TCC is describing a left-in hot or energized meter situation. Like all the other TDSPs

     37 Response to Cities 30-14 Attachment 1.
     38 Response to Cities 16-20.

     DIRECT TESTIMONY                             68                                 GOODFRIEND
             who report on this measure, TCC is meeting this target for reconnection on energized

 2           meters. TCC is reporting a measure based on less than full scenarios.

 3                       TCC REPORTED BILLING ACCURACY MEASURE

 4   Q.      DOES MR. HOOPER REPORT ANY OTHER STATISTICS?

 5 A. In addition to his ISA reporting, Mr. Hooper reports a measure he describes as the

 6           percentage of bills that require no adjustments and indicates that for the period

 7           January through August this number is 98.74%. The 2003 measure is 98.78%.39 He

 8           claims that this statistic is a good indicator of meter reading and billing success.

 9   Q.      WHAT DO YOU MAKE OF HIS CLAIM?

10   A.      First, there is no definition showing how the statistic is constructed and what data are

11           used. Although Mr. Hooper provides no definition for his statistic, it appears to be

12           the same statistic that TCC has reported previously as the one measure TCC decided

13           to include in the ISA reports to the PUCT that was not specifically asked for: the

14           BILLADJ measure. Perhaps, BILLADJ was provided in response to a general ISA

15           request to include billing error information.

16                    Second, if this is BILLADJ, it is interesting to notice that this measure, unlike

17           the other ISA reported measures, shows very little variability: For 2001 the statistic

18           is 99.79. For 2002 the statistic is 99.86. For 2003, through August, as reported by

19           Mr. Hooper, the statistic is 98.74 and updated for all of 2003, the statistic is 98.78.

20           For example, if BILLADJ is measuring every bill that TCC sends, not just bills based

21           on meter reads to retail customers, but a larger universe of billings, then one would

22           expect this statistic to behave as it does. That is, the reason it has such low variability

     39 Response to Cities 30-13.

     DIRECT TESTIMONY                               69                                    GOODFRIEND
           may be because, as a statistical measure, BILLADJ isn't really providing much

 2         information of value from the perspective of assessing regulated utility billing quality.

 3                Third, if my suppositions above are all wrong, then I will simply point out that

 4         TCC is not currently meeting its Texas target for BILLADJ, which TCC reported in

 5         its 2001 ISA filing to the PUCT as being 99%.

 6                And fourth, other billing data provided by TCC in discovery, some filed

 7         confidentially and some not, indicate less than 99% billing accuracy when what is

 8         being measured is the sending of bills to REPs. The reported measure here is simply

 9         inconsistent with utility-specific data on estimated meter readings, cancellations and

10         rebillings, etc. provided to me by TCC in this proceeding.

11                2.      SERVICE QUALITY REPORTING: RECOMMENDATION

12   Q.    DO YOU HA VE ANY CONCLUDING REMARKS FOR THIS SECTION?

13   A.    First, confidential reporting of TDSP performance measures is contrary to good

14         regulation and results solely from an anomaly created in drafting the rule rather than

15         from regulatory intentions.    The reporting of performance measures by regulated

16         utilities is a tool for regulation, not a means to secrecy. The intention of Subst. R.

17         §25.88 is not to put information concerning a regulated TDSP with no competitors

18         and subject to rate regulation on par with information pertaining to competitive

19         entities such as REPs. For example, none of the ERCOT performance measures are

20         confidential because ERCOT files on behalf of itself. That ERCOT also files on

21         behalf of the TDSPs has created the anomalous result that information pertaining to

     DIRECT TESTIMONY                           70                                    GOODFRIEND
              TDSP perfonnance requested by the Commission is not available for analysis to

 2            anyone other than Staff able to review the confidential filings.40

 3                     Second, public reporting of TDSP performance measures is in the public

 4            interest.    The public reporting of TDSP perfonnance information can create

 5            benchmarks for further assessment and identification of the most pressing problems

 6            by those who have an interest in seeing performance problems identified and fixed.

 7                    Thus, the Commission should direct TCC to file as non-confidential the "B

 8            Report" portion of TCC's Quarterly Performance Report that ERCOT now files

 9           confidentially on behalf of TCC.

10                         III. REQUEST FOR GOOD CAUSE EXCEPTION

11           A.       NEITHER ABD O&M SERVICES NOR TRANSMISSION
12                    CONSTRUCTION SERVICES COMPLY WITH SUBST. R.
13                    §25.342(f)(D) OTHER SERVICE
14
15                    1.       REGULATED UTILITY PROVISION OF UNREGULATED
16                             SERVICES: DEFINITIONS AND DISTINCTIONS
17
18                                          LEGAL FRAMEWORK
19
20   Q.      WHAT FRAMEWORK WILL YOU USE TO EVALUATE TCC'S REQUEST?

21 A. I will be using the Substantive Rules governing Unbundling. Specifically, I will be

22           discussing §25.341 "Definitions" and §25.342 "Electric Business Separation," and in

23           particular, § 25.342 (f) "Separation of transmission and distribution utility services,"

24           of which the "Other service" rule is a part.

     40 This is data reported by ERCOT on the TDSPs behalf. ERCOT may send or sends this data to the TDSP
     under its right to contest the accuracy of the ERCOT Report. ERCOT must report TDSP information as
     confidential since any information relating specifically to any other entity (unless the Commission determines
     otherwise) must be confidentially reported. See Filing Requirements For Performance Measure Reporting
     Pursuant to PUC Subst. R. 25.88.

     DIRECT TESTIMONY                                   71                                         GOODFRIEND
     Q.       WHAT IS THIS FRAMEWORK?

 2   A.       The general objective of unbundling regulation is to promote fair and full competition

 3            by protecting the competitive process and to recognize and address the economic

 4            problems inherent in the offering of non-regulated services by a regulated utility.

 5                     When adopting §25.342, the Commission explained:

 6            .... the commission seeks to prohibit practices between regulated and competitive

 7            activities that may unreasonably restrict, impair, or reduce the level of competition

 8            during the transitional separation of personnel, information flow, functions, and

 9            operations, and after a competitive market is established.41

10   Q.       WHAT         ARE      THE       SPECIFIC      CONCERNS         WHEN     REGULATED

11            OPERATIONS ARE PERMITTED TO OFFER UNREGULATED SERVICES?

12   A.       There are three potential abuses: (1) cross-subsidy where the total cost of service

13           borne by ratepayers is too high when ratepayer dollars are used to support wholesale

14           operations, and these ratepayer dollars are potentially placed at risk for recovery;

15           (2) cross-subsidy where resources, management attention and effort are diverted from

16           retail regulated operations thereby degrading the quality ofretail service and (3) anti-

17           competitive restriction or retardation of potential or developing energy services

18           competition. Evidence indicates all three abuses are occurring here.

19   Q.      WHAT IS THE SPECIFIC RULE APPLICABLE TO TCC?

20   A.      The specific framework applicable to TCC is §25.342(f) "Separation of transmission

21           and distribution utility services."       This section distinguishes among five specific

     41 Order on adoption in Project No. 21083 at 2.

     DIRECT TESTIMONY                                  72                               GOODFRIEND
           services. Three of these five, namely "system" service, "discretionary service," and

 2         "other service", are important here.

 3   Q.    WHAT IS SYSTEM SERVICE?

 4   A.    System service is defined in §25.341 "Definitions." At the most basic level, System

 5         Service is service essential to the transmission and distribution of electricity.

 6         Recognizing that what is essential may change over time with market evolution, the

 7         Commission provides an explicitly non-exhaustive list.

 8   Q.    WHAT IS DISCRETIONARY SERVICE?

 9   A.   Discretionary Service is defined in §25.341 "Definitions." Discretionary Services are

10        related to, but not essential to, the transmission and distribution of electricity. TCC

11        includes what used to be called "miscellaneous services" among its Discretionary

12        Services, and charges Discretionary Services only to retail customers. Substantive

13        Rule further distinguishes between System and Discretionary Services through the

14        rate design required: System Service costs apply to all REP T&D customers whereas

15        Discretionary Services are designed as an explicit user-fee and charged (via the REP)

16        to the end-use customer who purchases the service.

17   Q.   HOW IS "OTHER SERVICE" DEFINED BY RULE?

18   A.   There is no definition for Other Service in §25.341 "Definitions." Rather, the Other

19        Service exception is defined by what is permitted. The complete Other Service rule

20        IS:

     DIRECT TESTIMONY                             73                               GOODFRIEND
 1   §25.342(1)(1) continued

 2   (D)   Other service.

 3         (i)     The offering of any other services shall be limited to those services which:

 4                 (I) maximize the value of transmission and distribution system service

 5                 facilities; and

 6                 (II) are provided without additional personnel and facilities other than those

 7                essential to the provision of transmission and distribution system services.

 8         (ii)   If the transmission and distribution utility offers a service under clause (i) of

 9         this subparagraph, the transmission and distribution utility shall:

10                (I)       track revenues and to the extent possible the costs for each service

11                separately;

12                (II)     offer the service on a non-discriminatory-basis, and if the commission

13                detennines that it is appropriate, pursuant to a commission-approved tariff,

14                and;

15                (III)    credit all revenues received from the offering of this service during the

16                test year after known and measurable adjustments are made to lower the

17                revenue requirement of the transmission and distribution utility on which the

18                rates are based.

19   Q.    PLEASE DISCUSS.

20   A.    Allowed TDSP offerings are for those services which: (1) maximize the value of

21         transmission and distribution system service facilities; and (2) are provided without

22         additional personnel and facilities other than those essential to the provision of

23         transmission and distribution system services.        Furthermore, the revenues from

     DIRECT TESTIMONY                            74                                   GOODFRIEND
              maximizing value from better utilization of essential, and thus required TDSP

 2            resources, are to be credited fully (after adjustment) to reduce system rates.

 3               THE QUID PRO QUO IN RULE-COMPLIANT OTHER SERVICE

 4   Q.       WHY PERMIT A REGULATED UTILITY TO PROVIDE OTHER SERVICE?

 5   A.       There is a potential upside for both ratepayers and the regulated utility. Revenues

 6           earned must ultimately be credited to ratepayers, but the regulated utility benefits

 7           from use of these revenues until the crediting occurs. This utility benefit is called

 8           "regulatory lag."

 9   Q.      WHAT EXACTLY IS REGULATORY LAG?

10   A.      Regulatory lag is the financial benefit a regulated utility achieves when its actual

11           revenues exceed its last rate case forecasted revenues. For revenue credits, the test

12           year adjustment which is applied to reduce the current revenue requirement also

13           operates as a forecast of future revenues to be credited. Thus, when the forecast is too

14           low, the utility has the use of revenues exceeding forecast until the next rate case.

15   Q.      PLEASE PROVIDE SOME EXAMPLES.

16   A.      In the UCOS proceeding, TCC forecasted revenues subject to revenue credit of about

17           $ 21 million and made this adjustment to reduce rates. Actual revenues exceeded the

18           forecast by about $16 million. 42 Until this rate proceeding, TCC has had the benefit

19           of these revenues exceeding forecast. This benefit can be likened to a zero interest

20           loan from ratepayers to the utility.

     42 Response to Cities 2-19 supplemental.

     DIRECT TESTIMONY                               75                                   GOODFRIEND
 1                     In the present proceeding, TCC is not providing adjustments for all on-going

 2            ABD projects.43 Also, TCC has proposed three new (or remodeled) Discretionary

 3            Service fees, Customized Maintenance Service, Facilities Monthly Maintenance

 4            Service and Emergency Maintenance Service.                  Although each of these is being

 5            offered "at the request of end-use customers," 44 TCC provides no revenue credit for

 6            these in this proceeding.

 7   Q.       DOES THE REGULATORY PROCESS SUPPORT REGULATORY LAG?

 8   A.      Yes.     The known and measurable standard for adjustments helps to bias the

 9           adjustment/forecast downward relative to all expected revenues.                 Thus, ICC's

10           provision of these emerging ABD and Discretionary Services can be expected to

11           contribute to regulatory lag.

12   Q.       BUT WON'T THE UTILITY MAKE A COUNTER LOAN TO RATEPAYERS

13           WHEN THE FORECAST PROVES TO BE TOO HIGH, CREATING A KIND

14           OF "REVERSE" REGULATORY LAG?

15   A.      No. In actual operation, there is no symmetry. Because the utility has the option of

16           coming in for a rate increase when its forecast of costs is too low, but must be brought

17           in at some opportunity cost of the use of regulatory resources if "over-earnings" are

18           suspected, regulatory lag does not operate symmetrically but benefits the utility.

19   Q.      WHAT          DOES        THE      OTHER         SERVICE         RULE     ACHIEVE      FOR

20           RATEPAYERS?

21   A.      Ratepayers get revenue credits, reducing the total revenue requirement.

     43 See Response to Cities 29-7.
     44 Response to Cities 20-lb and also Byrne Direct Testimony at 12.

     DIRECT TESTIMONY                                   76                                   GOODFRIEND
 1   Q.      HOW DOES THIS OCCUR WHEN OTHER SERVICE OFFERINGS ARE

 2           RULE-COMPLIANT?

 3   A.      Quite simply, compliant offerings indicate that the utility has found a way to squeeze

 4           out more revenue from the facilities and personnel that the ratepayer is already

 5           obligated to pay for. Using the rule language, rather than pay all the necessary fixed

 6           cost associated with essential but not-fully utilized facilities needed to serve them,

 7           ratepayers benefit when the utility finds a way to "maximize the value of the T&D

 8           service facilities."    The utility finds a way to provide some "other service" from

 9           "T&D system service facilities" without additional personnel and facilities other than

10           those "essential to the provision of T&D system services."

11   Q.      DO RA TEPAYERS ALWAYS BENEFIT WHEN THERE ARE REVENUES

12           TO CREDIT AGAINST THE TOTAL REVENUE REQUIREMENT'!

13   A.      No, ratepayers are assured benefit only under rule-compliant offerings as just

14           described. Offerings which are not rule-compliant are an invitation to abuse of retail

15           ratepayers through the kinds of cross-subsidies I identify above.

16                    As I show below, the possibility that personnel as well as idle capital may be

17           used to provide other services, is to see that opportunity for abuse of the Other

18           Service exception is readily available to TCC.         In my view this is why the

19           Commission crafted the Other service exception very narrowly.4 5

     45 Order on adoption, pps. 132-135.

     DIRECT TESTIMONY                              77                                  GOODFRIEND
 1                  DEFINING "ESSENTIAL" FOR RULE-COMPLIANCE

 2   Q.    WILL YOU OFFER SOME GUIDELINES FOR IDENTIFYING WHEN

 3         WHOLESALE SERVICE OFFERINGS MIGHT COMPLY WITH THE

 4         OTHER SERVICE EXCEPTION?

 5   A.    Ycs.   In this section, I suggest some necessary but not sufficient conditions for

 6         compliance.

 7   Q.    HOW MUST PERSONNEL AND FACILITIES "ESSENTIAL TO THE

 8         PROVISION        OF     TRANSMISSION           AND      DISTRIBUTION          SYSTEM

 9         SERVICES" BE DEFINED FOR RULE COMPLIANCE?

10   A.    Essential personnel and facilities have both a productive or process aspect and an

11         economic or "least cost" aspect. In other words, to assume ratepayers will benefit

12         from TCC's offering of Other Service, not only is the production or process required

13         to be essential to regulated utility operations, it must be the least cost way of getting

14         the job done.

15   Q.    DO YOU HAVE AN EXAMPLE?

16   A.    Yes.   Consider the off-system sales that FERC and the PUCT have historically

17        pennitted to regulated generation utilities. In this situation, there is idle generation

18         capacity and associated necessary labor. In other words, both the generator (with its

19        attendant size and performance characteristics) and its full-time operator are essential

20        in producing necessary retail electricity. Furthermore, and importantly, this method

21        of organizing production represents a least-cost method of organizing because retail

22         ratepayer costs are minimized. Said differently, to reliably and cheaply provide the

23         electricity needs of retail customers, it is necessary to have both generation which

     DIRECT TESTIMONY                           78                                    GOODFRIEND
           may exhibit excess or idle capacity at times and full-time labor capable of operating

 2         the generator at all times. No other form of capital-labor organization minimizes

 3         costs at retail.

 4   Q.    WHY DO YOU STRESS THIS LEAST COST ASPECT WHEN DEFINING

 5         ESSENTIAL SYSTEM SERVICE?

 6   A.   Because some other arrangement would essentially permit "slack" or unnecessary

 7         labor resources that weren't really essential to the retail service. Putting these "slack"

 8        or unnecessary labor resources on the retail payroll is just an implicit way of creating

 9         "additional personnel" for a non-retail purpose in contradiction of the Other Service

10        exception.

11                 Moreover, showing that this definition of "essential" is satisfied is required to

12        assured that ratepayers are getting an unambiguously good deal from regulated

13        provision of Other services. In the alternative, the regulated operation is simply a

14        shill for development of unregulated services, and ratepayers are experiencing

15         inflated costs in a general or across-the-board way, reflecting the fact that production

16        is organized for purposes other than efficient delivery of retail services.

17                 Cross-subsidy would be reflected in the kind of excess administrative and

18        general expenses that Dr. Patton finds is characteristic of TCC relative to peer

19        TDSPs.

     DIRECT TESTIMONY                            79                                     GOODFRIEND
     Q.    DO YOU HAVE AN ECONOMIC DEFINITION OF WHAT KIND OF

 2         TECHNOLOGIES OR PROCESSES USED TO PROVIDE T&D SYSTEM

 3         SERVICES COULD POTENTIALLY COMPLY WITH THE                                    OTHER

 4         SERVICE EXCEPTION?

·5   A.    Yes. Capital-only technologies are good candidates to comply. For example, land

 6         essential to the provision of T&D system services, if used for cattle-grazing and

 7         requiring no "additional personnel or facilities" for grazing would comply. During

 8         the test year, TCC provided facilities rental to Small Hydro of Texas and a land lease

 9         to Textel Tower Development.        Assuming TCC can demonstrate that (1) these

10         utilized facilities are essential to the provision of T&D system services and (2) no

11         additional personnel or facilities were necessary to effectuate this Other Service use,

12         then these two TCC offerings would comply.

13   Q.    DOES YOUR UNDERSTANDING OF THE COMMISSION EXCEPTION

14         MEAN THAT "CAPITAL-ONLY" TECHNOLOGIES ARE THE ONLY

15         KINDS OF ESSENTIAL SYSTEM FACILITIES THAN CAN COMPLY?

16   A.   No.   The Commission rejected PG&E's request that the Other Service limitation

17         require only idle utility assets or capacity be used to offer Other Service. In other

18        words, the Commission rejected the standard that no labor (personnel) services used

19        in providing essential facilities may be used to support Other Service.               In

20        characterizing PG&E's request as unnecessary, the Commission said: The ommission

     DIRECT TESTIMONY                          80                                   GOODFRIEND
              notes that "other services" will be very limited in scope and will be approved only

 2            after careful review.46

 3                     As the Commission indicated when adopting the rule, satisfying the

 4            requirements for compliant Other Service offerings requires careful review.

 5            However, this review of TCC Other Service offerings has not occurred.

 6                     2.      TCC HAS YET TO DEMONSTRATE COMPLIANCE WITH
 7                             THE OTHER SERVICE EXCEPTION
 8
 9   Q.       WHAT IS YOUR PURPOSE IN THIS SECTION OF YOUR TESTIMONY?

10 A. In this section of testimony, I explain that TCC has not attempted to show compliance

11            with the limitations on offering Other Service. Although TCC Witness Crowder tries

12            to suggest otherwise, this is a case of first impression for the Commission, regarding

13            whether or not any of TCC's ABD service offerings (including Transmission

14            Construction Services) comply with the rule.

15                          THIS IS A SITUATION OF FIRST IMPRESSION

16   Q.       WHY IS THIS A CASE OF FIRST IMPRESSION?

17   A.      TCC's discovery response shows that the issue of whether the actual services offered

18            by TCC comply with the rule has not been before the Commission.47 First, TCC has

19           no definition or standards (such as those I suggest above) by which it decides whether

20           its service offerings comply with the Other Service requirements. TCC's position is

     46 In addition to capital-011ly technologies, technologies and/or processes known as fixed proportions
     technologies could potentially qualify. For a regulated generation utility, the example provided previously of
     fixed proportions or ratio oflabor operations necessary for least cost generation is such a technology.
     47 Response to Cities 25-68.

     DIRECT TESTIMONY                                   81                                         GOODFRIEND
              that it decides on a case-by-case basis.48          Second, all prior discussion before the

 2            Commission, i.e., in the business separation proceedings, have always been couched

 3            in terms of "plans" and, of course, these have not been explicitly approved.49

 4                     Third, the discovery response and attachments show that plan descriptions

 5            themselves were simply pledges that the actual operations would satisfy the rule.

 6            Said differently, there was nothing for the Commission to approve.

 7   Q.       HOW HAS TCC SHOWN COMPLIANCE NOW THAT OTHER SERVICES

 8            ARE BEING MARKETED?

 9   A.       A pledge, rather a demonstration of compliance, continues to be TCC's approach,50

10            even now, with at least 15 kinds of ABD O&M services offered and Transmission

11            Construction Service projects, too.

12   Q.       WHAT        JUSTIFICATION               DOES      TCC      GIVE       FOR       HAVING         NO

13            COMPLIANCE SHOWING?

14   A.       Mr. Crowder reasons that there are Commission orders approvmg stipulated

15            agreements in a series of cases transferring transmission facilities to LCRA. In these

16            cases, he says, parties knew TCC would be providing construction-related O&M

17            services to LCRA, but nobody objected, therefore everything must be okay.51

     48 Specifically, TCC responded: TCC does not limit or restrict O&M services it provides to a list of distinct
          named services. Rather, TCC offers itself as an O&M services provider and determines on a case-by-case
          basis whether to provide a requested service. Response to Cities 25-69c
     49 See Response to Cities 25-68.
     SOsee Mr. Crowder's Direct Testimony at 23-24.

     51 See Response to Cities 25-68. See also Mr. Bailey's Direct Testimony for a discussion of the Transmission
     Constrnction Services cases before the Commission.

     DIRECT TESTIMONY                                     82                                      GOODFRIEND
     Q.      DOES MR. CROWDER'S DIRECT TESTIMONY FAIL TO DEMONSTRATE

 2           COMPLIANCE?

 3   A.      Truly, Mr. Crowley offers not a shred of evidence that any ABD services comply

 4           with the Other Services exception.

 5           INSTRUCTION TO CSW: NO ADDS SOLELY FOR OTHER SERVICE

 6   Q.      WHAT EVIDENCE DOES TCC NEED TO PRESENT'?

 7   A.      As I suggested above, "essential" must be defined in a way that holds ratepayers

 8           harmless for non-utility operations.       Second, I suggested properties of possibly

 9           compliant technologies.     And, third, the Commission has given CSW (TCC's

10           predecessor) clear additional instruction.

11   Q.      WHAT ADDITIONAL INSTRUCTION DID THE COMMISSION PROVIDE

12           TOCSW?

13 A. In accepting CSW's suggestion to remove a requirement that only existing personnel

14           and facilities may be used, the Commission said:

15                   The commission agrees with CSW that over time a T&D utility will add

16           facilities and employees; however the utility may not add facilities or employees for

17           the sole purpose of providing "other services."5 2

     52 Order on Adoption p.135.

     DIRECT TESTIMONY                              83                                GOODFRIEND
 1   Q.       WHAT COMPLIANCE ANALYSIS HAS TCC DONE WITH RESPECT TO

 2            THE       COMMISSION'S         DIRECTIVE        THAT      NO     FACILITIES        OR

 3            EMPLOYEES BE ADDED FOR THE SOLE PURPOSE OF PROVIDING

 4            OTHER SERVICE?

 5   A.       None. The exact question Cities posed was:

 6            Has AEPSC [AEP Service Corporation] performed any analysis of when activity

 7            levels associated with AEPSC ABD work require the addition of AEPSC personnel

 8           and/or other resources to maintain service levels to affiliates? If so provide. If now

 9           [sic], explain why not? Provide all responsive documents whether analyses or not.

10                    In response, TCC simply said:

11                    It has always been understood that no additional employees would be hired,

12           therefore there was no need to perform an analysis.           Accordingly, no such

13           documents exist.53

14                    Such pledges are no substitute for compliance, especially when the potential

15           for cross-subsidy and other abuse is so pronounced.

16            TWO EXAMPLE VIOLATIONS AND RELATED CROSS-SUBSIDIES

17           (1)      Prep Janning Expenses

18   Q.      CAN YOU PROVIDE SOME EXAMPLES WHERE TCC HAS ADDED

19           EMPLOYEES FOR THE SOLE PURPOSE OF PROVIDING OTHER

20           SERVICE?

21   A.      Yes. The first example is cross-subsidy via preplanning expenses.

     53 Response to Cities 25-70.

     DIRECT TESTIMONY                              84                                  GOODFRIEND
     Q.       WHAT AREPREPLANNINGCOSTS?

 2   A.       Preplanning expenses are costs incurred to offer third-party services that are not

 3            directly associated with a specific third-party project but which support overall third-

 4            party activities. These are primarily AEPSC ABD expenses but also include TCC

 5            expenses that are not associated with a specific ABD contract. S4

 6   Q.       IDENTIFY         THE     VIOLATION         ASSOCIATED      WITH      PREPLANNING

 7            EXPENSE.

 8   A.       TCC has hired additional personnel solely for the purpose of providing other service

 9            in violation of the rule. First, TCC admits, quite logically, that the total level of

IO           preplanning costs is dependent only on the level of ABD activity performed.SS In

11           other words, AEPSC adds perso1mel with increasing levels of ABD activity

12            performed.

13                    Second, under cost causation principles, this bigger "pie" of AEPSC ABD

14           personnel costs is then allocated to operating companies on the basis of kwh sales

15           and/or number of transmission pole miles (for both O&M and Transmission

16           Construction Services). Of course, these allocations are simply a way of distributing

17           these costs to operating companies. Said differently, TCC takes an increasing hit of

18           dollars when ABD activity levels increase, all else equal. Thus, under AEP allocation

19           rules, TCC has hired additional personnel solely for the purpose of providing

20            "other services," thereby violating the Commission's rule.

     S4 Direct Testimony of Calvin Crowder at 24.

     SS Response to Cities 25-78.

     DIRECT TESTIMONY                               85                                  GOODFRIEND
     Q.    HOW DOES THIS AFFECT THE QUID PRO QUO YOU DESCRIBED

 2         EARLIER BETWEEN RATEPAYERS AND THE REGULATED UTILITY

 3         ESTABLISHED IN THE OTHER SERVICE RULE?

 4   A.    There is no sense in which the AEPSC personnel performing the preplanning function

 5         bears any resemblance to an underutilized resource at TCC that is essential to the core

 6         business. An expansion of ABD business activities in Ohio, when it requires the

 7         addition of AEPSC personnel performing preplanning activities, can lead to

 8         additional personnel costs in Texas as the overhead increases, but TCC's share of the

 9         allocation pie remains the same.

10                As long as AEP insists on charging AEPSC overheads to TCC for ABD

11        service projects, whether O&M or Transmission Construction services, I believe TCC

12        cannot comply with the rule.

13   Q.   WHY?

14   A.   Extensive use of allocations to assign costs to operating companies creates an

15        operating cost structure for the regulated operating utility which is in a fundamental

16        way uncontrollable by the operating company. This amounts to a situation of "forced

17        hiring" of additional personnel solely for the development of the ABD function.

18        (2)     Use of TCC personnel in ABD O&M

19   Q.   DO YOU HAVE A SECOND EXAMPLE OF NON-COMPLIANCE?

20   A.   Yes, use ofTCC personnel in ABD O&M. The violation is not compelled to occur as

21        it is with AEPSC overheads. In other words, TCC has some discretion over whether

22        it adds a direct hire solely to support the Other Services function. However, in the

23        test year, TCC exercised this discretion in direct contradiction to PUC rule.

     DIRECT TESTIMONY                          86                                   GOODFRIEND
 1   Q.      PLEASE EXPLAIN.

 2   A.      Mr. Crowder provides an example which directly violates the rule. He explains that

 3           ABD losses exist because TCC has only recently begun to offer ABD service. He

 4           says, "The ABD employee primarily responsible for developing TCC ABD services

 5           was hired at the end of 2001 and began actively pursuing ABD opportunities in

 6           2002." 5 6

 7   Q.      HOW LARGE ARE THE CROSS-SUBSIDIES?

 8 A. I don't actually know, but I can provide some indication in the analysis that follows.

 9           For example, the required reversal of the negative test year margin of $133,850 in

10           Exhibit JCC-3 simply represents the tiptop of the potential cross-subsidy iceberg. It

11           became exposed when it was revealed as that part of the total amount that retail

12           ratepayers were initially asked to bear to support wholesale operations but then had to

13           be reversed because of poor results, i.e., insufficient wholesale revenue.

14                               THE EXTENT OF CROSS-SUBSIDY

15   Q.      WHAT EFFECT IS THERE ON RATEPAYERS WHEN TCC HIRES

16           ADDITIONAL PERSONNEL FOR THE SOLE PURPOSE OF PROVIDING

17           "OTHER SERVICES"?

18   A.      What appear to be revenue credits are actually charges of AEPSC overhead to retail

19           ratepayers first with possible "net" revenue credits second. As indicated above, this is

20           why Mr. Crowder had to zero out the negative test year margin of $133,850 before

21           crediting the cost of service.

     56 Witness Crowder at 33.

     DIRECT TESTIMONY                             87                                      GOODFRIEND
                       Exhibit JCC-3 makes it clear that the $149,803.88 in overheads allocated to

 2            TCC ratepayers were not fully offset by the distribution related revenues earned.

 3            TCC had to re-absorb the difference between the allocated AEPSC personnel costs

 4            and the revenues earned.

 5   Q.       WHAT DOLLARS ARE ASSOCIATED WITH CROSS-SUBSIDY OF ABD

 6            O&M SERVICES?

 7   A.       For O&M ABD services, preplanning expenses for ABD O&M are charged as

 8            common costs for all O&M services. In the test year, about $125,530 in preplanning

 9            expenses were assigned to transmission revenues and $149,803 were assigned to

10           distribution revenues.      Of the $125,530, $114,262 were AEPSC ABD preplanning

11           costs and $11,268 were TCC ABD preplanning costs; of the $149,803, $93,594 were

12           AEPSC ABD preplanning costs and $56,210 were TCC ABD preplanning costs.57

13           Thus, another way of looking at this cross-subsidy is to see that in the absence of

14           these expenses, revenue credits associated with O&M services would have been about

15           $275,000 more than they were in the test year.

16   Q.      TO       WHAT           EXTENT       ARE      AEPSC      PREPLANNING          COSTS

17           INCORPORATED                INTO    TCC'S     CHARGES       FOR     TRANSMISSION

18           CONSTRUCTION SERVICES?

19   A.      Preplanning costs are not charged as common costs, so the amount depends upon the

20           specific project.       TCC provides third-party transmission services using primarily

21           independent contractors and AEPSC personnel.              Specifically for third-party

22           transmission construction contracts, for LCRA AEPSC costs were about $19,444,000;

     57 Response to Cities 25-70c.

     DIRECT TESTIMONY                                88                               GOODFRIEND
              for MVEC, AEPSC costs were about $158,138 and for Sharyland, AEPSC costs were

 2            $172,947.      For the test year, AEPSC charged TCC $3.8 million dollars.58       In

 3           providing this service, TCC uses primarily AEPSC personnel to provide the

 4           management function and oversight of the independent contractors.

 5   Q.      COULD THE ACTUAL ADJUSTMENTS THAT TCC PROVIDES TO

 6           RATEPAYERS TO RECOGNIZE THE USE OF THESE "ADDITIONAL"

 7           AND       NON-ESSENTIAL                EXPENSES   (IMPROPERLY       PLACED       ON

 8           RATEPAYERS) BE TOO LOW?

 9   A.      Definitely. The reason is because the potential for cross-use of personnel between

10           regulated and unregulated activities at TCC is so widespread.

11   Q.      HOW HAVE YOU ILLUSTRATED THIS CROSS-SUBSIDY POTENTIAL?

12 A. I asked TCC to fill in a matrix showing the extent to which personnel performing

13           ABD Service work can do other categories of work, i.e., system service, discretionary

14           service, etc.     In the matrix, the "yes" answers mean that the job title/person is

15           transferable between and among "yes" activities.

16   Q.      PLEASE ILLUSTRATE HOW TO READ THE MATRIX "POTENTIAL FOR

17           CROSS-SUBSIDY              OF         WHOLESALE    OPERATIONS       BY     RETAIL

18           OPERATIONS (BY JOB TITLE)".

19 A. In the matrix below, the first entry is for CSA or Customer Service Associate.

20           Reading across from this job title, the "yes" responses mean this person could be

21           employed in providing ABD Services, or AEPSC services or System services or

22           Discretionary services but would not be a direct employee of TCC or another

     58 Direct Testimony of Mark A Bailey at 28.

     DIRECT TESTIMONY                                 89                            GOODFRIEND
              operating company.            The "yes" entries represent the great extent of fluidity or

2             transferability of personnel resources across and among regulated and unregulated

3             operations. 59

4
                                                      Figure 12
                     Potential for Cross-Subsidy of Wholesale Operations By Retail Operations
                                                    (By Job Title)
                                                                                                                  Competitive
                        ABD Services           AEPSC              TCC      Affiliate   System     Discretionary    Work(2)
    CSA, SR CSA, Lead CSA                       Yes                no        no         yes            yes           no
    Admin Assoc-Admin Assoc Ill                 Yes               yes        yes        yes            yes            no
    Billing Specialist 1-111                    Yes                no         no        yes            yes           no
    Pricing/Costing Analyst 1-111               Yes                no         no        ves            ves           no
    Market Transaction Coordinator              Yes                no         no        yes            yes            no
    Enqineer I - IV                             Yes               yes        yes        yes            yes           ves
    Supervisor                                  Yes               yes        yes        yes            yes           yes
    MV-90 Analyst                               Yes                no        no         yes            ves            no
    Load Research Data Analyst 1-111            Yes                no         no        yes            yes            no
    General Servicer (union position)            No               yes        yes        yes            yes           yes
    Meter Electrician (union position )--Meter
    Electrician A                                No               yes        yes        yes           yes            yes
    Field Operations Specialist (union)          No               yes        yes        yes           yes            no
    Meter Reader (nonunion)                      No               yes        yes        yes           yes            no

    (1) The company does not track job titles of employees used by contractors hired by the Company.
    (2) Employee classifications noted with a yes indicate that the job classification would be available to perform emergency
    repair services as defined in the PUCT rules.

    Source: Response to Cities 29-6, Attachment 1
5
6            To the extent AEP-TCC corporate objectives are to develop in-house expertise in

7            non-regulated areas, I expect TCC to seek as much cross-subsidy with its attendant

8            artificial inflation of retail costs, diversion of resources and degradation of retail

9            quality as the Commission will tolerate.

    59 The Response to Cities 29-6a is included in Workpapers.

    DIRECT TESTIMONY                                         90                                              GOODFRIEND
     Q.       WHAT ADJUSTMENT HAS TCC PROVIDED IN THIS CASE TO REMOVE

 2            THE EXPENSES OF PERSONNEL WORKING ON ABD PROJECTS?

 3   A.       TCC provides an adjustment of $523,533 to Miscellaneous General Expenses to

 4           remove these expenses.GO Mr. Crowder explains the activity6l but no one at TCC

 5           has demonstrated that this adjustment fully reflects the proper split between

 6           personnel for regulated versus unregulated activities. If TCC cannot track (as

 7           required by rule) and thus prove up this adjustment, I believe the Commission has a

 8           prima facie case of cross-subsidy.

 9                                     PROBLEMS OF DETECTION

10   Q.      WHY IS IT DIFFICULT TO DETECT CROSS-SUBSIDY OF ABD

11           SERVICES?

12   A.      Basically, as long as ratepayers receive revenue credits (as required by rule), TCC can

13           get away with any level of cross subsidy it wants, provided no one is able to

14           challenge that a particular person was improperly assigning time/resources between

15           retail and wholesale projects, and/or a particular adjustment to remove the ABD-

16           related expenses of TCC personnel was not correct.

17                    I say this is possible as long as ratepayers receive revenue credits because, as

18           TCC knows, customers are unlikely to object to revenue credits and consultants are

19           unlikely to question them. But in this case, in its quest for cash flow, TCC put these

20           credits "under water"62 and had to adjust its booked loss out. In zeroing out the loss

     60 Rate Filing Package, Schedule II D 2, Attachment Page 11 of 12, Adjustment 17.

     61 Direct Testimony of Calvin Crowder at 25.

     62 Distribution Revenue losses of $133,849.63. Exhibit JCC-3 page 1.

     DIRECT TESTIMONY                                  91                                GOODFRIEND
           in order to provide the revenue credit, TCC explicitly recognizes that its adjustment to

 2         remove the effects of TCC workers doing ABD work was too low. In other words,

 3        TCC had to further "adjust" its adjustment provided in the Rate Filing Package.

 4         Since this is so, the original adjustment is not correct.

 5   Q.    IS THERE ANOTHER WAY OF SEEING THAT THIS ADJUSTMENT OF

 6         $133, 850 BEGAN LIFE AS AN EXPLICIT CROSS-SUBSIDY?

 7   A.   Yes, another way of seeing this is that truly idle TCC resources, and truly essential

 8        resources as I have identified them above, when engaged in permissible additional

 9        economic activity on behalf of ratepayers never book a loss.

10                   EVIDENCE OF ANTI-COMPETITIVE POTENTIAL

11   Q.   HOW         CAN       CROSS-SUBSIDY             RETARD       DEVELOPMENT             OF

12        POTENTIALLY COMPETITIVE SERVICES?

13   A.   Cross-subsidy permits the retail regulated firm, when pricing at wholesale to charge

14        less than its full costs. Thus, it can charge prices below the market price and drive

15        out competitors. In response to Cities discovery, TCC could not make the required

16        showing that it prices at market for ABD services.

17   Q.   WHAT IS THE STATE OF POTENTIALLY COMPETITIVE ENERGY

18        SERVICES IN TCC?

19   A.   The PUCT has recently recognized the poor state of potentially competitive energy

20        services in the TCC service territory.          First, the Commission recently granted

21        exceptions permitting TCC to provide certain discretionary services (at retail) that

     DIRECT TESTIMONY                             92                                 GOODFRIEND
              neither Oncor nor CenterPoint are permitted to provide.63 The Commission permitted

 2            these exceptions, finding that certain competitive energy service offerings were not

 3            sufficiently developed at the present time in TCC's territory.

 4                     Second, in an effort to stimulate competition, the Commission had required

 5            TCC to seek to exit certain services by finding buyers for TCC's non-roadway

 6            lighting systems.      Yet, TCC's efforts failed to find potential buyers/competitors,

 7            although two of the four entities approached were "involved in the construction and

 8            maintenance of non-roadway and roadway lighting systems. "64

 9                    Of course, an anticompetitive opportunity is presented when potential

10            competitors are also potential contractors.65 However, I was unable to compare the

11            identity of these potential competitors with the list of contractors TCC employs in

12            providing ABD Services. A further competitive consideration is the fact that AEP

13           has an unregulated affiliate, Diversified Energy Contractors Company, LLC, in the

14           energy contracting business. 66

15                    As indicated above, it is disturbing that TCC can readily find sufficient

16           contractors to help it successfully perfo1m transmission construction projects,67 yet

17           fails to find contractors having T&D O&M/construction capabilities willing to

18           purchase non-roadway lighting assets.

     63 These five maintenance and rental Discretionary Services are described in the Direct Testimony of AEP
     Witness Byrne and the proposed tariffs are presented as Exhbits RB-1-5.

     64 Response to Cities 2-86 and 87.
     65 Independent contractor costs are at least 44% ofTCC Transmission Construction Services costs. Response to
     StaffBAl-4.
     66 Response to Cities 16-24, Attachment, page 1.
     67 The list of contractors used by TCC on three projects was provided in Response to Cities 25-71. See also
     Response to Cities 25-72s.

     DIRECT TESTIMONY                                   93                                       GOODFRIEND
 1   Q.       IS THERE ANOTHER COMPETITIVE ISSUE?

 2   A.       Transmission Construction projects, unlike its O&M services, do not carry common

 3            costs of preplanning or other overheads. Rather,     rec allocates AEPSC overheads to
 4            individual projects. 68 This form of allocation may permit discriminatory pricing that

 5            allows TCC some ability to recognize or assign overheads up and down depending on

 6            how competitively TCC needs to price to win the project.69 The ability to assign

 7            AEPSC personnel costs first to TCC retail ratepayers (discussed above) may permit

 8            undetectable cross-subsidy, thereby transferring actual wholesale overheads to retail

 9            costs. These opportunities can permit TCC to engage in potentially anticompetitive

10            pricing ("limit pricing") to frustrate competitors and discourage them from competing

11            with TCC's transmission construction projects. Finally, Witness Crowder points out

12            that a third-parties choice of   rec may be due to a lack of other providers. 70
13           B.       THE THIRD VIOLATION: TRANSMISSION CONSTRUCTION
14                    SERVICE IS NOT AN ESSENTIAL TDSP SYSTEM SERVICE
15
16   Q.      TCC SAYS TRANSMISSION CONSTRUCTION IS DIFFERENT FROM

17           OTHER THIRD-PARTY SERVICES IT PROVIDES. HOW SO?

18   A.      Yes. What Mr. Crowder is saying at page 35 of his direct testimony, lines 12-22 is

19           that TCC provision of Transmission Construction complies with some requirements

20            of the Other Service exception, nothing more.

     68 Response to Cities 29-5.

     69 See Response to Staff, BAl-4.

     70 Direct Testimony at 25.

     DIRECT TESTIMONY                                 94                                   GOODFRIEND
 1   Q.      PLEASE EXPLAIN.

 2   A.      TCC's discussion provides a nice distinction with its other ABD services. TCC notes

 3           that construction personnel are "like" capital assets in that costs of construction

 4           personnel are capitalized in rate base along with the asset they constrnct. TCC's use

 5           of these personnel are not expensed. When they are performing construction work for

 6           others, TCC argues, they bear no expense to TCC. What TCC has described here is a

 7           production process using fixed proportions of capital and labor, that, as I indicated

 8           earlier, may comply with requirements of the rule.

 9   Q.      WELL THEN SHOULD TCC'S WAIVER BE GRANTED?

IO   A.      Not so fast.    The fixed proportions requirement is a necessary but not sufficient

11           condition for compliance. Recall the need for a showing of essential service. In other

12           words, TCC must show that this production process used for Other Service is

13           necessary or required for ratepayers to receive retail services.

14                   Yet, unlike TCC, other TDSPs provide TDSP services without having to be in

15           the Transmission Construction Services business.        TCC provides its Transmission

16           Construction Service almost entirely with independent contractors and AEPSC

17           personnel, not TCC operations personnel. 7 1 It strains credibility to suggest that

18           Transmission Construction Service is simply further utilization of resources essential

19           for essential transmission and distribution system service.

     71 Response to StaffBAl-4.

     DIRECT TESTIMONY                              95                                 GOODFRIEND
     Q.    BUT ISN'T HAVING AEP IN THE TRANSMISSION CONSTRUCTION

 2        BUSINESS IN THE PUBLIC INTEREST?

 3   A.   Maybe so.      However, it does not follow that the regulated utility, TCC or its

 4        ratepayers, should be in the Transmission Construction Services business. If AEP

 5        wants to spin off its construction business from TCC, this is fine, and AEP can make

 6        all the profits it wants as a separate unregulated operation. Considering the potential

 7         for cross-subsidy, I recommend that TCC spin off its Transmission Construction

 8        business.

 9        C.      EFFECTS OF GRANTING A GOOD CAUSE EXCEPTION

IO   Q.   WHAT WILL BE THE EFFECTS OF GRANTING TCC'S REQUEST FOR

11        GOOD CAUSE EXCEPTION?

12   A.   The compliance issues I have identified create problems for public interest regulation.

13        There is no "good cause" for granting the exception. TCC already benefits from

14        regulatory lag.

15   Q.   WHAT ABOUT REVENUE CREDITS?

16   A.   If the waiver is granted, revenue credits will be split in half. On its face, this is "a tails

17        I win, heads you lose" proposition for ratepayers .

18                Moreover, the PUCT should not force captive ratepayers to be in the for-profit

19        transmission construction business with TCC.

     DIRECT TESTIMONY                             96                                     GOODFRIEND
 1   Q.       HOW WILL INCENTIVES CHANGE IF TCC IS ALLOWED TO PROFIT

 2            DIRECTLY              FROM   PROVIDING        TRANSMISSION           CONSTRUCTION

 3            SERVICES WITHIN THE REGULATED UTILITY OPERATION?

 4   A.       Up to now, ABD services have been offered in TCC's own and adjacent service

 5            areas.   It is TCC's position that Commission rule does not limit these offerings

 6            geographically. 72 It is TCC's position that its offerings are not confined to the distinct

 7           O&M services listed on Witness Crowder's Exhibit JCC-3.73 I can readily imagine

 8            significant personnel shifts as TCC becomes the staging area or profitable conduit

 9           whereby AEP grows its transmission construction capabilities.

10                     With the new ability to pocket profits, all the support services in TCC capable

11           of assisting the Transmission Construction opportunities can be brought to bear and

12           even more resources and attention will be stripped from TCC retail operations.

13           AEPSC overheads and TCC support personnel can be utilized as needed and either

14           priced in or priced out of the Transmission Company bids in order to generate

15           additional transmission construction business

16   Q.      WHAT          BENEFITS        ARE      ACHIEVED           IN     SEPARATING           THE

17           TRANSMISSION             CONSTRUCTION           SERVICES        BUSINESS        AS    YOU

18           RECOMMEND?

19   A.      First, cross-subsidies from retail operations are eliminated.               Second, with

20           Transmission Construction Services as a separate entity, TCC employees will have a

21           career path into the Transmission Construction Services company by demonstrating

     72 Response to Cities 25-79.

     73 Response to Cities 25-69.

     DIRECT TESTIMONY                               97                                    GOODFRIEND
           productivity as a TCC employee, rather than by diverting productivity from retail

 2         activities to benefit the in-house Transmission Construction Services company.

 3                 IV. PROPOSED DISCRETIONARY SERVICE FEES

 4   Q.    WHAT          PRINCIPLE       ORGANIZES           YOUR        RECOMMENDATIONS

 5         REGARDING THE LEVEL AND STRUCTURE OF DISCRETIONARY

 6         SERVICE FEES?

 7   A.    Pursuant to the unbundling requirements of SB7, the Commission more carefully

 8         crafted distinctions among types of services. These distinctions serve to support the

 9         development of a competitive market. This purpose should be reflected in the design

10        of permissible discretionary service fees, terms and conditions.

11   Q.   WHAT       DISTINCTION BETWEEN SYSTEM AND                           DISCRETIONARY

12        SERVICES EXISTS NOW?

13   A.   The current definitional distinction between system and discretionary services was

14        adopted in rule effective on or before January 1, 2002 in response to requirements for

15         unbundling.     While system services are "essential" to the regulated function,

16        discretionary services are related to, but not essential to the regulated function.

17   Q.   HOW HAS TCC INTERPRETED THIS DISTINCTION?

18 A. In the UCOS proceeding, TCC created (1) fees for traditional services that were

19        previously not priced (i.e., copying fee, routine com1ect fee), (2) restructured and

20        raised fees (e.g. for service calls, meter tests, dispatch orders and denial of access to

21        meter) and (3) introduced new fees.        These new for-fee services included Special

22        Products/Services, Non-Standard Communication and Special Meter Read services

23        and fees. The higher fees to be charged for existing services were raised to recover

     DIRECT TESTIMONY                           98                                     GOODFRIEND
 1           supervisory overhead and fully loaded labor rates, consistent with requirements for

 2           "fully embedded cost pricing" of discretionary service fees.

 3   Q.      HOW HAS THE COMMISSION INTERPRETED TCC'S DISTINCTIONS SO

 4           FAR?

 5   A.      The Commission Order accepted a stipulation among the parties.                    Thus, the

 6           Commission permitted all charges as proposed except it did not approve the Retail

 7           Electric Provider Set-up Fee as proposed by CPL or the Account History Fee as

 8           proposed by CPL. In addition, the Commission required that Staff be notified by

 9           CPL in each instance where an assessment pursuant to the Non-Standard

10           Communication Fee Rate Schedule was made. 74 All we know is that the Commission

11           accepted the negotiation among the parties.

12   Q.      IS THE DISTINCTION BETWEEN SYSTEM AND DISCRETIONARY

13           SERVICES AN EVOLVING AREA?

14   A.      That this is an evolving area is also made clear by the lack of standardization of

15           discretionary service charges and prices across the TDSPs tariffs.

16   Q.      WHY IS IT IMPORTANT TO KEEP THE DISTINCTION BETWEEN

17           SYSTEM AND DISCRETIONARY SERVICES IN MIND?

18   A.      First, as markets evolve, services that were non-essential may become essential. As

19           markets evolve, the level, construction and design of services subject to fees, that is

20           discretionary service fees, can influence the behavior of the TDSP, REPs and end-

21           users.

     74 Application of CPL Company for Approval of Unbundled Cost of Service Rate Pursuant to PURA§ 39.201
     and Public Utility Substantive Rule § 25.344.

     DIRECT TESTIMONY                               99                                     GOODFRIEND
                     Second, to an economist, a market price is just another piece of information

 2           (albeit an important piece). One cannot walk the halls of the Commission or ERCOT

 3           without hearing a call for "more price transparency."         Of course what is being

 4           requested is low cost access to or the dissemination of information that market

 5           participants need to make better choices, so markets function more efficiently and

 6           effectively.

 7                   In other words, account history and usage information is more akin to an

 8           "essential" or system service than to a discretionary service. It is interesting to note

 9           how rapidly an essential service can be created by events.

10   Q.      DO YOU HAVE AN EXAMPLE?

11   A.      Yes. For example, in CPL's last rate case prior to restructuring, Docket No. 14965,

12           stipulating parties agreed to modify CPL's proposed "history account" charge by

13           adding clarifying language that it applies only to requests for account history

14           information that is more than two years old.75 Using the language of Subst.R§25.341,

15           historical usage information that was two or more years old was "nonessential'' while

16           more recent information was an essential or system service.

17   Q.      HOW HAS TCC PROPOSED TO CHARGE FOR ACCOUNT HISTORY?

18   A.      TCC proposes to charge for every account history request unless the account history

19           information is required to be provided at no cost by PUCT rule. Specifically, TCC

20           says:

     75 Proposal For Decision PUC Docket No. 14965 at 271 .

     DIRECT TESTIMONY                                100                               GOODFRIEND
                       The Account History Fee is an hourly-rate fee charged to the customer or

 2                     the customer's authorized representative (the requester) to complete each

 3                     request for account history except requests for information that is required

 4                     to be provided at not cost by the PUCT's Substantive Rule. (The hourly fee

 5                     is $24.11 and materials costs are charged separately).76

 6   Q.       TO WHICH RULE DOES TCC REFER?

 7   A.       The current rule which addresses account history charges is Subst. R.§25.472(b).

 8            This rule addresses rights of individual customers to historical usage data from REPs.

 9            The rule does not speak to charges by a TDSP to end-use customers or its

10            representatives, such as an aggregator or REP.                The rule says that an individual

11            customer is entitled to request a 12-month usage history from its REP without charge

12            at least [emphasis added] once every 12 months.

13                     As written, notice that the mle permits the REP at its option to offer individual

14            usage history more often than once every 12 months without charge.                        Thus, even

15            considering an aggregator or REP as a customer, 77 the rule is permissive, allowing a

16            REP to make no charge for access to historical usage information.

     76 Schedule IV-J-2 page 24 of27 (Sponsored by TCC Witness Moncrief).
     77 Whether the rule even applies to an aggregator at all is open to debate. Typically, an aggregator is a buyers'
     agent, not a customer as defined by PURA. The Customer Protection Section of PURA Section 17 .002
     (Definitions) define a customer as any person in whose name service is billed, including government units, and
     any other entity with legal capacity to be billed for service. Aggregators operating as buyers' agents are not
     liable for payment of bills. An aggregator may not inherently be a customer of the REP (or as TCC seeks to
     analogize in this case, the TDSP).

     DIRECT TESTIMONY                                    101                                         GOODFRIEND
     Q.      WHAT HAS BEEN TCC'S CURRENT PRACTICE?

 2   A.      With respect aggregators, TCC's position is that it has a right to charge for any usage

 3           request for any active premise if the aggregator requests usage information more than

 4           one time in a   12~month   period.

 5   Q.      IS THIS A DISCRIMINATORY CHARGE?

 6   A.      It may be.      REPs, for example, have certain rights to usage information that

 7           aggregators do not. I do not know what TCC policy is regarding REP requests for

 8           historical usage information pursuant to either a switch request or pursuant to an ad

 9           hoc request for historical usage.

10   Q.      WHAT RIGHTS TO USAGE INFORMATION DOES A REP HAVE?

11   A.      ERCOT protocols specify clear rights to timely usage information. A REP has a right

12           to timely monthly usage information so that it may bill promptly.             When a REP

13           requests historical usage information on a switch transaction, the TDSP is to provide

14           12 months of usage information if available within two business days of the request

15           so that the REP may receive the infonnation within three business days from the time

16           the TDSP receives notice of the REP's request for historical usage data. 78

17   Q.      HOW      DOES        THE     TIMELY          RECEIPT     OF     HISTORICAL          USAGE

18           INFORMATION ASSIST THE REP?

19   A.      The REP must bargain upstream of its operations, matching power supplies with its

20           anticipated loads.    With good usage information, REPs can reduce forecast error,

21           thereby lowering costs and better managing risks in power supply acquisition. These

     78 See ERCOT Protocols, Section 15: Registration, 15.l.l.2 Provision of Historical Usage with a Switch
     Request, November l, 2003.

     DIRECT TESTIMONY                               102                                     GOODFRIEND
           costs reductions are ultimately passed on to customers. Knowledge the REP gains

 2         can also aid the REP in improving the marketing and pricing of its products.

 3   Q.    WHAT IS YOUR RECOMMENDATION REGARDING TCC'S PROPOSED

 4         ACCOUNT HISTORY FEE?

 5 A. I recommend that the service provided be a system service and costs associated be

 6         part of the cost of service. The Account History Fee has provided no recordable

 7         revenue for discretionary services as it has no test year revenue registered. Second,

 8         unimpeded customer, REP of record, and aggregator of record access to current usage

 9        information is necessary to support the competitive process. In other words, account

10        history and usage information is more akin to a system service than a discretionary

11        service. Said differently, TCC should not be permitted to erect barriers to the free

12        flow of important market information. Thus, there should be no charge for providing

13        account history information upon request to an end-user, aggregator or REP.

14   Q.   PLEASE EXPLAIN THE REASONS YOU INCLUDE AGGREGATORS IN

15        YOUR RECOMMENDATION.

16   A.   One of the largest aggregators in Texas performs aggregation services for government

17        agency customers of TCC. This aggregator is the South Texas Aggregation Project or

18        STAP.

19   Q.   WHAT IS STAP?

20   A.   STAP is a non-profit political subdivision formed to combine the individual electric

21        requirements of its members into an aggregated pool in order to realize volume

22        savings on purchasing electric services to its members. Membership to ST AP is open

23        to any political subdivision that purchases electricity for their respective public

     DIRECT TESTIMONY                          103                                 GOODFRIEND
           facilities. The current membership of STAP consists of 40 cities, a regional transit

 2         authority and a river authority.

 3   Q.    HOW IS STAP'S ECONOMIC FUNCTION LIKE THE REPS' ECONOMIC

 4         FUNCTION?

 5   A.    STAP operates as a buyers' agent. Potentially, aggregation is a way to gain at least

 6         part of the economic benefit that pooling provides to REP suppliers for STAP

 7         members in the form of reduced prices.

 8                 REPs do the same thing on behalf of individual members, which is part of the

 9         reason why individual REPs "specialize" in serving particular customers.             REPs'

10         profit margins are, in part, a return for providing this pooling benefit to individual

11         customers.

12                 But STAP aggregation has other helpful economic functions for the market,

13         too.

14   Q.    PLEASE DESCRIBE STAP'S ECONOMIC FUNCTIONS IN MORE DETAIL.

15   A.    STAP performs three distinct economic functions. First, STAP provides information

16         to REPs about the cost of serving the load represented by STAP. Thus, the more

17         accurate and timely this information is the better REPs are able to judge actual costs

18         and the lower the risk premium for uncertainty will be in the REPs' bids. Also, good

19         quality information supports the REPs' ability to recognize, match, and thus

20         differentiate their bids to reflect the value of ST AP load to their particular operation.

21                 Second, STAP's access to information allows it to better judge the received

22         bids. From the buyers' side, this increases accuracy in selecting the best parties for

23         further negotiation. (From an economic efficiency point of view, the "best parties"

     DIRECT TESTIMONY                            104                                    GOODFRIEND
           are those for whom contracting with STAP creates the largest gains for both STAP

 2         and the REP relative to other possible pairings).       Both these first and second

 3         functions, then, have to do with making the size of the bargaining "pie" as large as

 4         possible. The third function addresses how the pie gets sliced. For this, STAP uses

 5         information to bargain to increase its members' share of potential gains.

 6   Q.    WHAT DOES STAP NEED TO PERFORM ALL THREE ECONOMIC

 7         FUNCTIONS WELL?

 8 A. If ST AP is to perform all three functions well, then timely access to accurate, good

 9         quality, usage and cost (billing) information is key. Moreover, if STAP is to have

10         bargaining power vis-a-vis REP offers, then this requires STAP to have the same kind

11        of access to this kind of information that REPs have.

12   Q.    WHAT       ARE     THE      DOWNSIDES          WHEN       STAP'S      ACCESS       TO

13        INFORMATION IS NOT ON A PAR WITH REPS?

14   A.    When STAP access to information is not on par with REP access, then bargaining

15         between them is not "symmetric" but biased in favor of the better-informed REPs.

16        From a market point of view, this is not the greatest loss, however. STAP's basic

17        role as a source of infomrntion to the market to help identify the best "supply fit" is

18         also compromised. This second loss reflects an inefficiency imposed on the entire

19        market.    The inefficiency is created when there is excessive cost in getting

20        economically valuable information into the market. Like other market participants

21        acting in self-interest, a byproduct of STAP's self-interested desire for and use of

22        better quality information is that market decisions will be made based on better

23         quality information.

     DIRECT TESTIMONY                          105                                     GOODFRIEND
 1   Q.       SO, YOU ARE RECOMMENDING THE ELIMINATION OF THE ACCOUNT

 2            HISTORY          FEE   FOR     STAP       ON    THE      BASIS     AS     YOU     ARE

 3            RECOMMENDING IT FOR OTHER MARKET PARTICIPANTS?

 4   A.       Yes, I am.

 5   Q.       BUT WON'T PROVIDING ACCOUNT HISTORY SERVICES FOR FREE

 6            LEAD TO ABUSE?

 7 A. It is hard to imagine a request for Account History information from an end-user,

 8            REP of record or Aggregator of record that would not be a bona fide request. From

 9            the requester's side, the transaction is not costless. However, should TCC identify

10            abuse, TCC can request the ability to institute a charge for providing this information.

11            However, TCC should not be allowed to substitute other charges in place of the

12            Account History charge.

13   Q.       DO YOU HAVE OTHER RECOMMENDATIONS TO SUPPORT THE

14            DISSEMINATION OF INFORMATION IMPORTANT TO THE MARKET?

15   A.       Yes. TCC indicates that Special Meter Reading fee applies when an estimated bill is

16           outstanding. 79 This charge should be prohibited, particularly given the volume of

17           TCC's use of estimated meter reads. The proposed 6.1.2.1.6 Special Meter Reading

18           Fee should not be charged when a REP, aggregator or end-user requests an actual

19           meter read on an outstanding bill with estimated usage.

     79 Response to Cities 15-2.

     DIRECT TESTIMONY                             106                                   GOODFRIEND
 1                That this fee not be charged in the case of an outstanding estimated bill is

 2         especially important since TCC has counter-incentives to creating the information.

 3         For example, I identified incentives for TCC to create regulatory lag earlier to gain

 4         the benefits from actual revenues exceeding test-year projections/adjustments.

 5                When it comes to meter reading it appears that the cost savings from using

 6         estimated readings (as considered earlier in Section III) are only enhanced by

 7        regulatory lag revenue opportunities. TCC introduced the Special Meter Reading Fee

 8         in the UCOS case. TCC earned $ 385,000 on 25,716 occurrences. These Special

 9        Meter Read earnings create a counter-incentive to return estimated meter reads to

10         levels which existed prior to Customer Choice.

11   Q.   DO YOU HAVE OTHER RECOMMENDATIONS TO BETTER ALIGN

12        INCENTIVES WITH MARKET NEEDS?

13   A.   Yes. First, the proposed Inaccessible Meter Fee should remain as a Denial of Access

14        Fee.   (However, the editorial change from "Company's" to "Billing" Meter, as

15        proposed to implement the Competitive Metering Rulemaking, should be permitted).

16        Not only does modifying the existing charge in the way TCC proposes create an

17        incentive for even more estimated meter reads, but there is not potential recourse for

18        the REP. TCC is not responsible for showing evidence of denial, and there is no way

19        REPs or ratepayers have of assuring that the Meter Reader didn't just take a donut

20        break and chalked it up as an Inaccessible Meter Fee.

21                Second, the 6.1.2.1.16 Special Billing Services Fee, 6.1.2.1.13 Copy Fee or

22        6.1.2.15 Special Products/Service Fee shall not be charged for the educational service

23        of providing a detailed billing and invoicing analysis and report to requesting REPs

     DIRECT TESTIMONY                          107                                 GOODFRIEND
 1           and aggregators, upon request, or to provide a manual with equivalent functionality in

 2           its place. The provision of this service, at no cost, will move TCC toward practices of

 3           other TDSPs in ERCOT.

 4                V.    REQUEST FOR PRE-APPROVAL OF DEBT RECOVERY

 5   Q.      WHAT IS TCC REQUESTING?

 6   A.      Essentially, TCC is requesting pre-approval for a specific accounting treatment of a

 7           possible future debt.      In other words, TCC is asking the PUCT to pre-approve a

 8           regulatory asset contingent on REP bad debt expense.            TCC states its request as:

 9           Approve TCC's request to defer any bad debt expenses incurred in providing service

10           to REPs and include such costs in TCC's next base rate case. 80

11                     Another way of explaining this request is that TCC is effectively requesting

12           the right to a guaranteed payment from ratepayers for REP bad debt expense it might

13           incur.    Lamenting its inability to get a credit deposit upfront from REPS under

14           existing rule,81 TCC is effectively asking for one from ratepayers by virtue of the

15           requested pre-approval.

16   Q.      OF WHAT BENEFIT TO TCC IS THIS PRE-APPROVAL?

17   A.      TCC explains that GAAP does not permit TCC to record a loss for possible future

18           recovery in the event of a CR bankruptcy without some form of assurance of future

     80 Direct Testimony of TCC Witness Carpenter at 61.
     81 Direct Testimony of TCC Witness Laine, at 20-25 and Exhibit JLL-2, See also Direct Testimony of TCC
     Witness Hamlett at 44-45.

     DIRECT TESTIMONY                                 108                                   GOODFRIEND
 1              recovery. 82 So absent pennissive statute, rule or order, TCC cannot book a regulatory

 2              asset in the fonn of a future receivable from customers. 83

 3   Q.         WHAT WILLTCC DO IF THE REQUEST IS NOT APPROVED?

 4 A. If the request is not approved, bad debt expense cannot be recognized as a regulatory

 5              asset.   And, the Commission's treatment of any bad debt expense that TCC books

 6              now will not be detennined in this proceeding. 84 However, TCC must still create an

 7              accounting transaction to recognize recovery and/or write-off.

 8   Q.         WHAT HAS BEEN TCC'S EXPERIENCE THUS FAR WITH RESPECT TO

 9              THE TCE BANKRUPTCY?

10 A. In discovery, TCC provided a summary proof of claim that the company filed in May

11              with the Bankruptcy Court for approximately $3.5 million. Within that claim, TCC

12              shows a deposit recoupment of about $600,000 or a net claim of about $2.9 million

13             dollars.85

14                       TCC filed a supplemental discovery response on February 2, 2004 indicating

15              that it had set up an accounting transaction to recognize its TCE bankruptcy claims.

16             In its response, however, TCC did not it explain why TCC chose to recognize only

     82 Response to Cities 16-8c(4).
     83 See Direct Testimony of Witness Hamlett at 45.

     84   Based on TCC's description of current practice with respect to potential uncollectibles, what TCC will do is
           recognize the debt. TCC has the option to deemed such debt uncollectible and charge off a portion or all of
           it, or not, depending on the likelihood of subsequent payment. The Company will determine a net
           uncollectible amount after applying any security or other valid credit. Subsequent repayment on a
           previously charged-off amount can be recognized in a re-invoicing of the debt. See Response to Cities 8-6

     85 Exercising the delinquency provision as permitted under its existing tariff Deposit Requirements (Section
           4.5.1), TCC had required a deposit from TCE in the amount of $740,000, which TCE provided as a Letter
           of Credit.

     DIRECT TESTIMONY                                     109                                         GOODFRIEND
 1           $ 1.5 million as the potential amount subject to write-off of the $3.086 million TCC

 2           now claims it is owed by TCE. 86

 3   Q.      WHAT ELSE HAS TRANSPIRED SINCE TCC FILED ITS PROOF OF

 4           CLAIM?

 5 A. In December 2003, TCE announced a reorganization plan. The TCE press release

 6           indicates that all creditors, including TDSPs, receive 100% payback of negotiated

 7           debt. TCE goes on to detail the nature of the new financing that will "enable TCE to

 8           continue its business growth. 11 87

 9   Q.      DID THE MARKET LEARN FROM THE TCE BANKRUPTCY?

10   A.      Yes. The market has and is responding to reduce the likelihood that the facts leading

11           to the TCE bankruptcy will occur again. First, as I understand it, TCE followed a

12           purchasing strategy that made the REP uniquely vulnerable to swings in Balancing

13           Energy Schedule (otherwise known as spot market) prices. Second, in response to

14           TCE's bankrnptcy, ERCOT reviewed and tightened its collateral requirements for

15           Balancing Energy market participation. 88 Third, a recently completed PUCT Staff

16           investigation indicates that TXU's ability to operate as a pivotal bidder may have

17           contributed to the unexpectedly high Balancing Energy Schedule prices that TCE

18           paid. The Staff investigation suggests options to address this price-setting ability. 89

     86 Updated Response to Cities 8-9.

     87 TCE Press Release of December 12,2003 provided in Workpapers.
     88 Effective September 1, 2003, ERCOT revised Protocols to calculate additional collateral requirements for
     Qualified Scheduling Entities intending to utilize the Relaxed Balance Schedules more than 20%. Protocol
     Revision Request No. 43 IPRR available from www.ercot.com.
     89 See generally, Staff Inquiry into Allegations Made by Texas Commercial Energy regarding ERCOT Market
     Manipulation, Project No. 25937, Market Oversight Division, January 28,2004.

     DIRECT TESTIMONY                                 110                                       GOODFRIEND
 1   Q.       WHAT KIND OF ANALYSIS HAS TCC DONE TO SUPPORT ITS

 2            REQUEST?

 3   A.       None. The company characterizes its Highly Sensitive Response 1-37 as an analysis.

 4            It is not an analysis. What TCC calls financial exposure is simply a calculation of

 5            monthly invoiced amounts by REP. Thus, all TCC has done is calculated how many

 6            dollars TCC could hold, interest free, if TCC were able to obtain a credit deposit from

 7           every REP active in its service territory from the time the REP began to serve in its

 8           territory.

 9                    In discovery, TCC has also provided its record of invoice delinquencies for

10           each REP.90        While Mr. Laine suggests this information is somehow useful in

11           identifying bankruptcy exposure risk, I accept the alternative view, presented by

12           Mr. Hamlett, that pending bankruptcy may be unrelated to prior payment patterns,

13           including invoice delinquencies. My review of the REP invoice delinquency record

14           provided in discovery also supports Mr. Hamlett's view.91

15   Q.      IS GRANTING THE REQUEST PREMATURE?

16   A.      Yes, for six independent reasons.                First, The PUCT is m the process of rule

17           improvement that will help REPs better manage debt exposure from end-use

     90 Highly Sensitive Response to Cities 2-32, Attachment 1.
     91 See Response to Cities 8-21.

     DIRECT TESTIMONY                                   111                               GOODFRIEND
              customer payment patterns.          This, in tum, can be expected to improve cash flow

 2            management by REPs.92

 3                     Second, TCC said it has not analyzed the effects of ongoing and potential

 4            improvements in the ERCOT settlement process because it impacts REPS, not

 5            TDSPs. 93 However, quicker settlements have an effect on REP cash management

 6            practices, and thus again are responsive to TDSP concerns about the likelihood of

 7            REP bankruptcies and TDSP potential financial exposure.

 8                     Third, as discussed above, TCC should be careful in analogizing from the

 9            TCE situation as to the likelihood of bankruptcy and TDSP potential exposure.

10                    Fourth, the Commission made a clear policy choice in prohibiting TDSPs

11            from imposing credit requirements beyond those currently permitted.94                           TCC

12            provides no cost-benefit analysis for why existing policy should be changed.

13                    Fifth, TCC's actual request is for a PUCT promise-to-pay, which permits TCC

14            to employ its requested regulatory asset accounting. Yet, TCC provides no evidence

15           to support the underlying judgment and balancing of interests that a promise-to-pay

16           would force the PUCT to make in this proceeding.

     92 Specifically, the Commission has proposed revisions to §25.478 Credit Requirements and Deposits. The rule
     preamble states that the current revision of the Consumer Protection Rules, as proposed, is expected to help
     REPs better manage their bad debt exposure. Instead of the higher of 1/6 annual billing or the sum of estimated
     billings for the next two months, the Commission proposes to allow a maximum deposit of one-fifth estimated
     annual billings. The Commission explains that this is roughly equivalent to 80 days of usage a REP is likely to
     pay before service to a non-paying customer can be terminated. Under § 25.483 Disconnection of Service, the
     Commission proposes to allow non-affiliated REPs a new right to disconnect small commercial and residential
     for non-payment beginning June 1, 2004. For non-residential customers, the REP may require the customer to
     pay an initial or additional deposit if the customer cannot demonstrate satisfactory credit to the REP.
     (§ 25.478(b)). Project No. 27084, Staff Draft Proposal as approved at the October 9, 2003 Open Meeting.

     93 Response to Cities 8-23.
     94 See Preamble, Order on Adoption, §25.107 and §25.108, Project 21082.

     DIRECT TESTIMONY                                   112                                         GOODFRIEND
                      Finally, as TCC recognizes, the promise-to-pay would provide justification for

 2            TCC's real objective which is a change in PUCT policy to permit the TDSP to extract

 3            credit deposits regardless of REP creditworthiness. This, too, is contrary to existing

 4            PUCT policy.95

 5                                    VI. RATE CASE EXPENSES

 6   Q.       PLEASE IDENTIFY THE FEES AND EXPENSES CHARGED TO CITIES

 7            FOR YOUR WORK IN THIS CASE.

 8   A.       As of January 31, 2004 I have billed Cities $54,589.20 in fees and my associate,

 9            Mr. King has billed $9,874.50. I have incurred $84.78 in non-fee expenses provided

10            in this case. These figures include hours charged as follows:

11
     Name                              Hourly Rate                       Hours
     Sarah Goodfriend                  275                               198.50 (decimal)
     Kelso King                        150                               65.83 (decimal)
12
13   Q.       DO YOU HA VE AN OPINION CONCERNING THE REASONABLENESS OF

14            THE TOTAL AMOUNT CHARGED TO CITIES?

15   A.       Yes.   The hours charged and expenses incurred were necessary to perform the

16            assigned tasks in a professional and timely manner. The out-of-pocket expenses were

17            incurred to aid in the provision of such services.

18                    TCC is the first TDSP to come before the Commission in a traditional rate

19           proceeding since Customer Choice began, and so many of the decisions in this case

20            may become precedential in establishing standards for the regulation of TDSP

     95 See existing and proposed Consumer Protection Rules which distinguish end-user credit requirements the
          REP may impose according to creditworthiness of end-use customers. Project No. 27084, Staff Draft
          Proposal as approved at the October 9, 2003 Open Meeting.

     DIRECT TESTIMONY                                113                                       GOODFRIEND
           companies in the new era. The scope and length of my testimony reflect this fact.

 2         Moreover, there has been constant revision and turnover in· market rules and

 3         substantive rules as ERCOT stakeholder groups and the PUCT have struggled to keep

 4         pace with constantly changing market issues. This is a very challenging situation for

 5         policy evaluation and requires intense levels of investigation and fact gathering.

 6         These case attributes are reflected, for example, in the size of TC C's original filing, its

 7         revisions, and the extent of information requests filed by intervenor groups. Under

 8         these conditions, I conclude that the amounts charged are reasonable.

 9   Q.    BRIEFLY DESCRIBE THE SERVICES PROVIDED BY YOUR FIRM.

10 A. I was retained by Cities to investigate the quality of service that market participants,

11         and REPs, in particular, are receiving from TCC.          I was retained to identify any

12         discriminatory and/or anti-competitive issues associated with TCC's proposed tariff

13         offerings and to spot and develop positions on other requests made in TCC's filing

14         that could negatively impact the competitive market or the PUCT's stewardship in

15         ensuring the development of a competitive retail market as envisioned by PURA.

16   Q.    DOES YOUR FIRM CHARGE A REASONABLE HOURLY RATE?

17   A.    Yes.   The hourly rate shown above is my normal billing rate and based on my

18         experience, is comparable (or lower than) the hourly rates charged by other regulatory

19         consultants with similar background, experience and training providing similar

20         services. This is based on my experience in many utility rate cases and review of

21         consulting fees charged by other consultants with comparable background and

22         experience.

     DIRECT TESTIMONY                            114                                    GOODFRIEND
     Q.    DID YOU OR MR. KING BILL IN EXCESS OF 12 OR MORE HOURS IN

 2         ONE DAY?

 3   A.    No.

 4   Q.    DO YOUR EXPENSES INCLUDE HOTEL OR LODGING COSTS IN

 5         EXCESS OF $100.00 PER NIGHT?

 6   A.    No.

 7   Q.    HA VE YOU CHARGED CITIES FOR MEAL EXPENSES IN EXCESS OF

 8         $25.00 PER PERSON?

 9   A.    No.

10   Q.    DID YOU USE NON-COMMERCIAL AIRCRAFT OR FIRST-CLASS AIR

11         TRAVEL?

12   A.    No.

13   Q.   DO YOUR RATE CASE EXPENSES INCLUDE ANY LUXURY ITEMS SUCH

14        AS LIMOUSINE SERVICE, SPORTING EVENTS, ALCOHOLIC DRINKS,

15        HOTEL MOVIES OR OTHER ENTERTAINMENT?

16   A.   No.

17   Q.   HAVE YOUR FEES AND EXPENSES BEEN DOCUMENTED?

18   A.   Yes. The monthly invoices submitted to the Cities include the time billed, the hourly

19        rate charged, and a description of professional services rendered.       The invoices

20        accurately reflect the time spent and expenditures I incurred on Cities behalf.

21        Similarly, Mr. King's monthly invoices submitted to Cities include the time billed, the

22        hourly rate charged, and a description of professional services rendered.

     DIRECT TESTIMONY                         115                                  GOODFRIEND
 1         Documentation of long distance, copying and delivery expenses are attached to the

 2         invoices.

 3   Q.    PLEASE DESCRIBE ANY STEPS YOU TOOK TO KEEP FEES AND

 4         EXPENSES TO A MINIMUM.

 5   A.    First, Goodfriend Consulting is working under a phased contract with a spending

 6         limit established by estimate before the work was done. Goodfriend Consulting must

 7         obtain prior approval from the Cities for any billings in excess of the estimate.

 8                Second, my familiarity and experience as a regulatory decisionrnaker and as

 9         an expert witness in proceedings involving the AEP-CSW companies has helped

10         reduce hours expended, as has prior experience in providing advice and consulting

11         services to REPs active in the ERCOT market. Third, anticipating the many novel

12         issues in this proceeding, I brought Mr. King in at the outset of the proceeding to

13        assist me with data gathering and issue analysis in order to reduce the overall cost of

14        my services. Finally, since I am located in Austin, expenses associated with this case

15        will also be kept to a minimum.

16   Q.   DO YOU ESTIMATE INCURRING COSTS BEYOND JANUARY 2004?

17   A.   Yes.    There are several tasks to be completed, including finalization of issues,

18         finalization of testimony, preparing for hearing and appearing to testify. I will also

19        aid counsel in preparing cross-examination, briefs, and exceptions as requested. I

20        estimate that I will spend 70 hours and will incur additional fees and expenses of

21        $19,360 to complete this case before the PUCT. If the case is appealed, I may be

22        called upon to assist counsel through the appellate courts incurring costs of

23        approximately $550. In total, I estimate future fees and expenses of $19,910.

     DIRECT TESTIMONY                           116                                   GOODFRIEND
                 In order to reduce the reliance on estimates, I intend to submit an affidavit

2         identifying the actual incurred costs prior to completing the case.

3   Q.    DOES THIS CONCLUDE YOUR DIRECT TESTIMONY?

4   A.   Yes, it does.

    DIRECT TESTIMONY                           117                               GOODFRIEND