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Electricity - Rates and Costs

( Originally Published Early 1900's )



THE SUBJECT of this talk as announced is Rates and Costs. In a sense that is putting the cart before the horse; because costs are not consequent on rates, excepting only when the rates are by competition or by legislation so fixed that proper service is made impossible, because it costs too much. Properly, the text should run, Costs and Rates, or Costs Influencing Rates. When the influence is the other way, when the rate fixes the cost, there is something wrong—there is something that requires adjustment in the conditions.

Maintain the Value of the Plant

I think that the best statement I can make of the principles which should govern the management of an electric lighting property like ours, and the making of the rates to customers, is contained in the instructions which were given me something like eleven years ago, not quite eleven years ago, when I undertook to become the manager of The Edison Illuminating property. Those instructions were stated by Mr. Peck, the President of the Company (and still the President), as the principles which had governed his policy, and I have never seen any occasion to require a change in his statement of principles. His first statement was this: "You must keep up your property; you must maintain it so that its value is the same at the end of the year as it was at the beginning of the year." He said, "That is the first thing to do as the manager or director of a property, because, if you do not keep up the property, if you allow it to run down, presently there will be no property, and the business will end." A rundown property cannot be operated profitably. It may be sold, but we are not talking about selling; we are talking about running, about staying in the business. Now, I wish you would fix that in your minds clearly. It seems to be the wrong order of things to talk about maintenance and repairs before you talk about operating, or about wages, or about dividends, but that is just exactly how the thing begins. You have to keep your plant in running order before you do anything else. If you can't keep your plant in running order you are going out of business, and that settles the whole question. You have to keep it in such order that it will give good service, or people won't buy your product. That is the sine qua non. You may go without paying dividends to your stockholders as long as they will stand for it; and you may make your rates as low as you please and no one will object; or you may raise them until the customers howl so that you have to stop. But your plant must continue to go along; and if you do not keep that plant in operating condition you are going out of business, sure. So that Mr. Peck's first principle to keep up the value of your plant, to maintain it as good as it was a year ago, is the first principle of this business; and I think of all kinds of business. In some businesses that rule is laid down by law. A national bank must make good at once any impairment of its capital. And the capital of a bank is to all intents and purposes the plant of a bank. A bank is a device for trading in and loaning money, and naturally it must keep its initial stock of money. The law requires the national bank to make good at once any impairment of its capital. I would not be a bit sorry, as a manager of a public service corporation on a salary, to see a law requiring that we must make good at once any impairment of the property. We are actually compelled to do so. But the law that compels us is a law of economics; not a law laid down by a legislature.

Wages and Profit

Now, Mr. Peck said to me, "After you have done that, then there are two next things to do; the first is to pay your help going wages and a little better." I think those of you who have been with us long enough to consider our policy, and to understand our policy, will recognize that as the straight rule that we have always gone by; the rule of paying help the going wages and a little better. Not a great deal better. You cannot afford to do that and stay in business; but it is well to pay a little better, so that you can keep the right kind of help. Without passing out any compliments, I think I may say that rule has worked mighty well in this service.

The other next thing Mr. Peck said—not the next thing in time, because it comes in at the same time—"is to pay your stockholders a reasonable dividend." Now, right here, let me put into this talk the rule for a reasonable dividend, or a reasonable profit. A reasonable profit to people who invest their money in any business, is that amount of profit which will bring to the business freely the amount of money which it needs; neither more than that nor less than that. Now, you can see at once the sense of not taking a profit less than will bring to the business the money which it needs. If you take a less profit you are not going to get the money for your extensions, and you will be stopped from extending; and moreover, you will have a grouchy lot of stock-holders. Obviously, you must pay a profit large enough to bring the money into the business. The other thing is not so obvious, but it is just as true; namely, that you must not, particularly in a public service corporation, pay a profit larger than is necessary to bring the money freely to the business. Mind you, I say to bring the money freely to the business. I have seen money just wrung out of the stock-holders. They were told, "You have to put this money up, or you will lose what you have already put in;" while they said, "It looks like throwing good money after bad." They put the money in, but not freely. Freely is what I mean. People will put money freely into a paying business upon a reasonable showing of profit. Now, if you pay a bigger profit than that, what is going to happen: You are going to have more money than you want, more money than you can use, more money than the business needs. Suppose you take it? It leads you into all sorts of foolish things. I know by my own experience that when there is lots of money in the treasury I am tempted to spend it on things that are not needed and that afterwards prove to be a waste of money. Supposing you do not take it. There are then people saying,"There is lots of money in this business, why can't we get into it?"And the first thing you know they are bucking you, in competition. And that is a worse thing than if you pay too small a profit. If you pay too small a profit you don't get the money, and if you pay too big a profit you encourage competition. Either way the business suffers, and either way—and don't forget that, though it does not concern us directly, as it concerns our customers, don't for-get it—that if the money cannot be had for extensions, the public suffers. And if there is too much money coming in, and the plant is duplicated, and if there are two plants covering the ground when only one plant is necessary, the public suffers again. In the long run the public always suffers by either of those mistakes. Somebody has to pay for that waste of money, and it has to come out of the business in the long run.

Now, these two things go side by side: Your stockholders must have a reasonable profit and your employes must have going pay, and (according to our rule) a little bit better. If the stockholders do not get their share the employes cannot expect to get theirs. The two stand on the same footing exactly. And if things are good for the stockholders, application for an increase of salary, or for a general raise, can be looked at favorably; when the stockholders are getting nothing it is clearly a case of stand-off; when one goes up the other should go up; when one goes down, the other must expect, sooner or later, to go down. When there is no money to pay dividends to the owners of the business it is time to talk about 5 or 10 per cent reductions in pay. It is a long, long time since we have had to talk about that. The time may come; do not forget that; that is not meant as a warning, but don't overlook it. If things get so we cannot pay our interest and a reasonable dividend to our stockholders, the reduction of expenses, either by reducing the number of men or by a reduction of wages, must be in order. It is the rule of business. It is an economic law as absolute as the law of gravity.

The Equitable Rate

Now, finally, after you have kept up your plant and paid your employes a little better than the going pay and paid your stock-holders a dividend, properly comes the last thing. If over and above these two requirements there remains an excess of revenue, cut down your rates. You are taking in more than the business needs, and the permanent business, the permanently profitable business, is the business that is run on the smallest margin of profit that will bring the money freely to the business. Excessive profit is a mistake. It chases off our customers to burn gas, and it chases off the customers of the Gas Company to burn kerosene. Now, these are the rules, and they are not merely statements of opinion by Mr Peck—a very capable man who has been in business a great many years and who has been in active management of this Company from its beginning—but they are the dead open and shut rules of political economy. These rules must govern your business or your business must go to the bad. Nor am I stating these rules as my opinion, but stating them as rules that through a lifetime of public service employment I have found to be absolutely imperative. And I have given you the manner and the order in which Mr. Peck put them, not to carry with it the weight of his name, which counts for some-thing with us who know him, but because it is a concise and definite way of stating the facts.

Now, having run the business on those lines; having the money and knowing what the money is going to cost in the way of interest and reasonable profits; having built the plant and knowing what it is going to cost to make your current and distribute it, with all the extras that go into that, all the matters of service to customers, which are such a big item of expense to us; and having a pretty close guess, from last year and the year before and the general look of the business, how much current we are going to sell this year, there comes before us the question: At what price are we going to sell? Now, it is perfectly clear to you that all these things which I have stated as being required must be included in the price; you must run your business; you must keep up your plant; you must pay your salaries and your dividends; and in saying you must run your business, I am figuring on paying your taxes, your insurance, all the other odds and ends, though they do not come properly into what we call the operating expenses, yet are inevitably a part of the running of the business—it is perfectly clear to you that all these things must be included in the price that is to be charged. Now, supposing you had only one customer, just one, and that customer could not get away; it would be a mighty easy matter to say to that customer,"Here is your annual bill, here is what it costs to run the thing; there is the payroll, there the dividends, there the maintenance of the plant; we have taken stock, and we are just as well off in our plant and in our storeroom—we have just as much coal in the yard, and as much supplies in the storeroom, and as much value in the plant as we had last year at this time; and this bill is up to you to pay—please pay." It would be an easy problem. But that is not the way we have to do business. Our customer is collectively fifteen thousand people, more or less, and each of them has his own notions about such things. What is more, each of them differs in his requirements, one way and another, from every other one of the lot. There are no two customers whose requirements are identically just the same. So that having settled what is the total price we should collect for a year's work, there comes the question: How are you going to distribute that total among those customers? You see we have now stepped from the question of costs to the question of rates. Now, I will put in here my definition of an equitable rate. It is this: An equitable rate is that rate which will collect from each customer the cost of his service—including in the cost, of course, the cost of up-keep of the plant—the cost of his service, and a reasonable profit on the investment necessary to serve that customer. Now, to find out the cost of his service looks easy; you see by the meter how many units he has had. But when you come to look closely at it, it proves to be not quite so easy as it seems; because one man is served over a very cheap overhead line; another man is served over expensive underground wires; one man is served on direct current, another man is served with an alternating current, and the cost of conversion from the alternating to the direct current is a charge against the direct current business and not against the alternating current business; one man takes current for power, and he does not care if the pressure varies 3 or 4 per cent each way; another man wants current for incandescent lighting and he lets us know right away if there is 1 per cent variation each way; one man, in spite of all we can tell him, burns his lamps until they are black as the top of your hat; another man has whimsical conceptions about renewals and sends in for new lamps every week. But when you come to examine the great majority of these things you will find they are the things that result from conditions which are in no wise the fault of the man or which he cannot control; or that in such other matters as the frequency of renewal of lamps, one man being careless about his lamps, and another man careful. Such matters are comparatively small variants in the cost of the service. The important exception is that one man is served with light that he must have at a regular pressure and another man is served for power and does not require close regulation or lamp trimming or renewals. Not to confuse the issue, I want you, while noting these variations, to let them pass for a minute, and assume that the cost of service, the actual cost of running the plant, is the same for each unit sold.

The Equation of the Rate

Assuming, then, that the cost of running the plant and maintaining it is the same for each unit sold, then it follows that you can distribute the cost of the service to each customer in proportion to the number of units he takes. That settles the first part of the problem. The figure then is COST PER UNIT plus INVESTMENT CHARGE. That is the equation of the rate. Remember I have said to you there are some important differences in the cost of different units sold, such as units sold with or without lamp service; we will assume in the meantime that the cost is the same for each unit; the difference is ot enough to come into the problem at this time. Now, you consider the investment charge for each customer. Supposing our total investment charge is, roughly, half a million a year. Now, just to make easy figuring we will say our investment charge is six hundred thousand a year. It is getting there mighty fast. That is to say: A reasonable charge for the investment we will say is $600,000: Suppose we have 15,000 customers. It looks dead easy to divide by 15,000 and say "$40 apiece." I would like to know how many of our customers would stand for paying annually $40 of investment charges plus running cost. There would be trouble at once. I can imagine a string of people piling in on Mr. Vieson to tell him what they think of him.

But take it the other way: Supposing we are selling thirty million units, let me see—my memory has gone back on me there. Take a figure nearer the general business sales: Supposing we are selling for our general lighting and power business—throw the street railway business overboard just now—suppose we are selling for our general lighting and power business, in round numbers, twenty million units. Assume that. Now we will try again. Twenty millions into $600,000. That equals 3 cents a unit investment charge. There is going to be trouble, quick. It is perfectly evident that if we add the running charge to that it will bring us an average rate of something like 5M or 6 cents. How much of our power business is going to stand for that? Not a bit of it. It would be just pie for the Gas Company to sell gas to gas engine customers if we charged 5M or 6 cents straight for power. Please figure it—$600,000 running charges; operating charges 2M to 3 cents; rate 5M to 6 cents. It would be pie for them to compete against a rate like that. Still, you will say, if that is the proper way to do it, why not do it. It is up to me now to show it is not the proper way.

Demand and Investment

It is not the proper way, first of all, for this reason, that the cost of the investment necessary to serve any customer is in no way what-ever measured by the number of units the customer takes. Now let me illustrate (blackboard) :

(A) 5 kilowatt motor, average 6 hours full load daily. Then, 5 kw X 6 hours X 25 working days = 750 kwh

(B) 100, 16 cp. lamps = 5 kilowatts, dusk till 6 p. m. Then, 5 kw X 1 2/5 hours X 25 days =175 kwh

We have a customer who has a 5-kilowatt motor, and he really runs it at full load 6 hours a day, or part load 10 hours—lots of our customers think they run at full load when they don't, you know. Say he runs it full load, equal to 6 hours a day; that is 30 units a day, 750 units a month of 25 working days. Here is our case, 5 kilowatts demand and 750 kilowatt-hours monthly. Now, we have another customer who has just the same demand; he has 100 incandescent lights. Take this other customer who has the same demand, he has 100 sixteens equal to 5 kilowatts; he turns them on at this time of year about a quarter to five or five o'clock; he shuts his shop at six; he uses his demand, say 35 hours a month. Now, we have this result. See what it looks like. Here is the same investment required to serve the one customer as is required to serve the other : 5 kilowatts of our plant at Delray, 5 kilowatts of trunk lines, of substations; 5 kilowatts clear up to the meter; the same for each customer; one customer gets the bill for 750 kilowatt-hours, and the other gets it only for 175. Now, it is clear as daylight, if you consider these two customers, that the investment charge should be the same to each of them, be-cause we have to make an identical investment sufficient to supply current to each of them, up to 5 kilowatts, at any time they want it. By way of putting it clearly, suppose the customer that has the 100 lights is a wholesale house downstairs, and the customer that has the 5-kilowatt motor is right above in the same building. They are served right off the same mains. Each man must pay for half the investment, yet the bill for the man that has the motor is for 750 units and for the man that has the light is only for 175. If we attempt to distribute the fixed charge according to that ratio this man will pay more than four times as much as that man, and should pay the same. If we intend to make each man pay reasonable profit on the investment to serve him, we will miss it by just 400 per cent, and that is more error than we care to have in our accounting.

The Energy Contract

Now, let me go off sideways a little. If I were talking simply about equity I would stop my argument right here, but I am talking now about the business sense of our people here. It is quite certain that either of those two men could take care of himself; this man with the motor could put in a small gas engine or a steam engine; if he put in a small gas engine he would buy gas, if he put in a small steam engine he would buy coal. Either way he would pay bulk rates: so much for a cubic foot of gas, or so much for a ton of coal. Each could do substantially the same thing. The man who now uses a motor would probably not bother to put in a dynamo but would run his shafting direct from his engine. The man with the lights would put in a dynamo to run his own lights. Each one would make substantially the same investment to serve himself. Now, here is the business of it. If each would have to put in that investment to serve himself, and we undertake to serve them, we are saving each of those men substantially the same investment. Each man, by taking service from us, avoids making an investment. That means that each man by taking service from us puts the investment on us. Each man avoids making just the same investment. That means that each man by taking service from us makes us make the same investment. It follows, then, that each man should pay a reasonable profit on the same investment, although the one man takes monthly more than four times as much current as the other. Right there is the underlying reason of the differential rate. Now, supposing we went to those two men and said to each of them, "You may contract with us to pay us annually so much profit, and so much to make good our investment itself, that will include the profit on our investment and the taxes we have to pay, and it will also include a certain part of our depreciation."

If he will do so, what he pays by the year will be according to the amount of the investment we have to make for him. If we make twice as much investment, then we will charge him twice as much by the year, and so on. We say to him, "That includes our profit. After you pay that we will sell you all the current you want at cost with a little item of what we call management profit, but practically at cost." As to the item of management profit, so-called; it seems to me it is a mistake to call it by that name, because it should really be management expense—something added to the actual average cost, to represent the extra supervision that comes in with increased output. What we actually do is to send to those people and say, "You can have an Energy Contract on our regular form, under which we will make the investment to serve you, and you will pay us a profit on the investment over and above our maintenance and taxes, etc., and then we will sell you all the current you want at what it costs us to make it." We actually ask $54 a year per kilowatt, plus 1 cent per kilowatt-hour. And now that is as plain as daylight.

That is equitable. Each man pays us according to the investment he puts upon us. And then he pays the cost of running the plant, of making the current which he uses. We have our profit in the first item; it is there in the $54 per annum. It is there for three years in that form of contract; and having that guaranty we do not hesitate to make the investment for this man and a lot more like him, to serve them. And then we are willing to run or not to run, just as the case may be.

This man, then, would pay us at the rate of $54 a year for 5 kilo-watts, and so would the other man. This man would pay us at the rate of 1 cent per kilowatt-hour for 750 kilowatt-hours, and the other man for 175. Now, that is as plain as a pike staff.

Here is our $4.50 a month, equal to $54 a year. Here 5 times $4.50, is $22.50. The same for both. Then 750 at 1 cent, $7.50, that makes this bill $30, while this man's bill is the same, $22.50, plus $1.75, equal to $24.25. Now that looks reasonable enough, the way I have explained it; but when you come to put that down at the average rate, this man pays 4 cents per kilowatt-hour; 750 kilowatt-hours at 4 cents equals $30. That is the way it works out. Of course, I am not now speaking of discount for prompt payment. This other man uses 175 units, $24.25, nearly 14 cents per kilowatt-hour. Then there is trouble right away. And yet on the face of it we have charged those two people the same rate, and we are not making one bit more profit on the one man than on the other; and if you look closely at the thing, it is so, not only on the face of it, but as the absolute under-lying fact. Nevertheless this second man kicks like the dickens be-cause his rate is 175 into $ 24.25-somebody who is quicker in figures can figure that. It is 13.9 per kilowatt-hour. And this first man's rate is only 4 cents; but the cold fact remains that we are making no more profit on the one man than on the other. And you can see it.

That is our everyday experience. When we go and tell a man he is up against the 14.4 net rate, he gets madder than a wet hen. He says, you sell such a man current at 4 cents—and we do; but we do not make any more profit on him. But when we say so to our friend, he tells us promptly that when we die we won't go to heaven. Nevertheless, if that man will sit down and figure the thing out, he will see that the proposition is not only generally equitable in a broad way, but is mathematically correct as near as you can make such a thing.

A Rate to Encourage Small Industries

Now, I think my demonstration up to this point, is simple enough. You have before you the proposition of the straight Energy Contract. There is a modification of that which you all know of, the 4-cent power rate. We make a 4-cent power rate to customers who say they are running their motors regular factory hours, not less than 8 hours a day, 48 hours a week. That rate is made as a matter of policy and for convenience, but it is an equitable rate. There are a great many small consumers who do not see their way to guarantee us $54 per kilowatt per year. They say they are afraid to guarantee $54 a year—they have had a dull time in the summer, etc., etc. But we know to a certainty that of these small consumers the other man is busy when this man is idle, and the other man is working overtime when this man has a dull time, and we know the aver-age of all these customers proves up correctly, and that each man of them is keeping regular factory hours. Do not overlook that for a moment. Varying seasons, dull seasons and busy seasons, working overtime sometimes, and short time at other times, that the whole aggregate works out on this same plan of $54 plus 1 cent—works out a 4-cent rate. When we dropped that power rate from 5 cents to 4 cents, it was because our experience showed us by the checking up of a thousand or more such customers, that 4 cents was a fair rate, taking each of those customers from year to year, and also for the aggregate; and thus we meet the case of the man who could not afford to guarantee us a profit for three years.

That 4-cent rate has done more than anything else I know of in this town to build up our multiplicity of small industries. Now, I want to say frankly about that rate, that it is a little low; that 4-cent rate is a little lower than it should be to be evenly profitable with the rest of our business, but it still pays us a sufficient profit. A 5-cent rate would be a bit high, and a 4-cent rate is a little low. But we do not want any fractional rates. And when we came to consider whether we should stick at 5 cents until we could afford to drop to 4, or to drop now and let the thing average over four or five years, we decided to drop now to 4, because we saw that the encouragement of these small factories was the best thing we could do for Detroit, and doing it for Detroit we were doing it for ourselves. Whatever helps this town helps us. Do not forget that, any man of you. Do not forget to boom your own town, because you are helping your own business. If this town prospers, we prosper. We looked at that matter from the standpoint of long-headed men, and we said that there is no contribution we can make to the efforts of the members of the Board of Commerce to get factories to come—there is no subscription we can make to aid Detroit against other towns—there is no shouting we can do as to what a fine town we have, that will do our town, and thereby our own business, so much good as to make a low rate to small factory power consumers. But we did not make a rate that was a loss. Let me say right here, No public service corporation has any right to do business at a loss. We took a lower profit on that rate than the average profit, but still we do not lose on it. And we stand bound by that rule, that we cannot do business at a loss, and the reason we cannot do business at a loss is this: If we do business for one man at a loss, we have to make it up on another man; and to serve all the public equitably, we have no right to wilfully lose money on one man and make it up on another. So that whenever we have made what seems a low rate, it was always made with the perfect assurance there was no loss in it.

The Differential Rate or Demand Contract

Now, let us consider the next thing, the differential rate, pure and simple—the so-called 16 and 4 combination. That is not quite so plain as the Energy Contract rate—fixed charges plus running charges. But it comes in this way: A great many people, when you put this Energy Contract up to them, this $54 plus 1 cent, will shake their heads for a reason not already pointed out to-night. It is the limitation of the contract to the delivery of energy. They want us to look after their arc lamps, and to look after their motors and to put in fuses, and it cost Mr. Thompson's department something like a matter of $40,000 a year to do these things. Do not grin at that.

His men are inspecting motors and replacing fuses and trimming lamps for customers, and exchanging incandescent lamps. These Energy Contract customers do not get any of that service, and a great many of our customers want it. Furthermore, these customers say, "We have times when we are not so busy, and times when we are busy, and we would like to have this thing go up and down a bit, both as to the profit and as to the running expense of the business." Then on top of all that, when we began to figure this way, we had to make a change from a straight rate with a discount to some kind of a differential rate, and it wasn't easy to make that change. The Wright system, so-called, the 16 and 4 system, went very far in the desired direction. When we started that system we went to the customer and we said, "Your rate is now 16 cents, and you get a discount up to 20 per cent for your gross bills. Now, we are going to make a reduction in rates, but we are not going to touch the 16 cents; we are going to make it so that you, when you use our investment a long time, will begin to get a low rate." We explained to him just what I have been explaining here; that the investment does not depend upon the kilowatt-hours, but depends upon the demand. We said to him, "We want to fix this new deal so that the low rate will come to the man who is entitled to it. What we are going to do is to fix things so that you will keep paying 16 cents a unit until you have paid your fixed charges for the year, after that you will pay a much lower price." The profit, though, of this 16 and 4 system is in the 4 cents just the same as it is in the 16 cents. In the other case, remember, when we made a rate of $54 a year plus 1 cent, all the profit is in the $54. There is no profit in the 1 cent at all. In this case, now, when we make a rate of 16 cents followed on by 4 cents, there is just the same profit stuck on a unit at 4 cents as there is on a unit at 16 cents; namely, something over 2 cents. The difference between the 1 cent and the 4 cents is first of all the service of in-candescent lamp renewals and arc lamp trimming, and all these things that go with the use of our arc lamps and our investment in incandescent lamps; and the rest of the difference is our profit. In this particular proposition you see, instead of bunching our profit into an annual charge we put it this way:

SIXTEEN-CENT RATE equals COST plus FIXED CHARGE plus PROFIT.

FOUR-CENT RATE equals COST plus PROFIT.

Now, please keep the hang of that. The 16-cent rate is cost and profit with the fixed charge also. The secondary or 4-cent rate has only cost and profit.

This brings me to the point of fixed charges. The fixed charges of a plant, in the sense in which I am now talking—and I think right here I will just change that word to the more correct one. That is the common way of putting it, but it is better this way.

SIXTEEN-CENT RATE equals COST plus STANDING CHARGE plus PROFIT.

The standing charge on the plant is not the profit. It is some-thing different. I have to elaborate that a bit, so you will get the importance of that differentiation. Supposing your plant was doing no business but ready to do it. Supposing just for a minute, that your customers all boycotted you, the whole 15,000 of them. Sup-posing not a one of them would order out the meter. Supposing they said, we are going to hold you to be ready to serve us any minute the same as we used to, but we are not going to use a single unit through the meter. Just imagine that. What could we do to cut down expense? Well, right away quick there would be a saving in coal. That is sure. But we would not save all the coal. We would have to keep enough boilers fired to pull the maximum load. Those customers, if they could get together and refuse to use any light, then might get together and turn on all the lights at once, and we would have to be ready for them. When it comes dusk, the week before Christmas, we would have to be ready to take care of the load of 18,000 kilowatts just the same as we were last Christmas; we would have to have the same generators running, for the assumption is the load can be snapped on at once. There would have to be just the same number of people ready to attend fires. There would have to be as many fires under the boilers, but we would not burn as much coal. All the coal we would burn would be just enough to keep up the steam. If we really had that condition at Delray there would be a nice lot of blowing safety valves. We would have just as many firemen, because the same boilers would be fired; and there would have to be just as many men standing by. We would have to have just the same number of engineers; we would have to have just as many superintendents; just the same all through, excepting this: There would not be as much coal to handle. Think it over, and you will see there will be a little saving on the boiler gang, a little saving in repairs to the furnace arches, and we could probably drop a little on the coal hoisting gang. But that is all we could save. The payroll would hardly drop at all. The coal bill would drop a good deal. The incandescent lamp renewals would drop. The bill for carbons would drop a good deal. But our trimmers would have to be retained. The standing condition of the plant then would mean that only a small part of our expenses would be cut off. It follows that merely to be ready to serve customers makes not only the investment expense, but makes a great deal of what is commonly considered to be running expense. Now, the sum of all these expenses to which a plant would be put, is what is called in this equation the standing charge; and that standing charge has to be just the same, whether a customer is ready to turn on his lights and does not turn them on, or whether he turns them on and burns them all night. If he turns them on and burns them all night, it costs us a little more coal and lamp renewals, but it does not cost us another blessed thing.

Now let us look outside of the plant. Look at the lines. What is it that uses up our wires and poles? It is weather and rot and wind and sleet; and poles, and cross-arms, and insulation on wire are not used up one bit quicker because you send the current over the lines. You do not blow fuses if you have no current, that is true. Remember that by this assumption of readiness to serve, that the trans-formers must be hot. When you come down to the underground system, there will be just as much looking after it when idle as when working, because the underground system in the seven years since we last rebuilt it has never failed because of load or overload. It has always failed because of corrosion, rust or electrolysis, or some other of a hundred and fifty things that make expense for us but that do not depend upon whether we are doing business or not.

Now, I think you will see, if you think it out, that to be ready to serve the customer means a great deal more than just having the plant ready. As far as I know, gentlemen, if our customers started in to boycott us, as suggested, we could fire Mr. Masterson's gang, and that is all we could fire. Well, I guess we could drop some of Mr. Vieson's force, too. But just each one of you think of his own job, and then imagine for a minute that we had to be ready every day and every night to serve our customers, but that the customers were not taking current, and each of you put the question to himself, "Can the Company do without me?" and you will be surprised how very few of you can say "yes" to that. Most of you would say, "No, if we are to be ready to furnish current, but not furnishing it, my job would have to go on just the same."

Having now got a clear idea of what is meant by standing charge, let us come back to our equations on the blackboard.

SIXTEEN-CENT RATE equals RUNNING COST plus STANDING CHARGE plus PROFIT.

FOUR-CENT RATE equals RUNNING COST plus PROFIT.

The fixed charge under the Energy Contract includes the standing charge for the year and the profit for the year But under the 16 and 4 contract, or Demand Contract as we call it, the profit is distributed so much on each unit sold. There is the same amount of profit in each unit sold at 16 cents as there is in each unit sold at 4 cents, neither more nor less. The 16-cent rate differs from the 4-cent rate under this contract only in that it includes the standing charges. We take the standing charges as estimated for a year and spread them over 360 hours' use of the demand—that is to say, 30 hours' use of the demand each month. The 16-cent rate then includes the running cost per unit and one three-hundred-andsixtieth part of the standing charge for the year per kilowatt of demand and a uniform item of profit per unit. The 4-cent rate includes the running cost per unit and the profit per unit. Do not overlook the fact when you compare the 4-cent rate of the Demand Contract with the 1-cent rate of the Energy Contract that the 4-cent rate includes also use and trimming of arc lamps, use and renewals of incandescent lamps, motor inspection, and emergency repairs. None of these things are included in the 1-cent rate of the Energy Contract and it is the addition of these, as well as of the profit to the 1-cent running expense, that brings the figure up to 4 cents. And please be quite clear that there is just as much profit to us on our investment in the 4-cent rate of the Demand Contract as there is in the 16-cent rate. The difference between the two is out-of-pocket expenses only, and these expenses must be paid before any profit can begin.

Please consider now what it costs us to run a man's lights all night instead of stopping at six o'clock; it will illustrate the same idea. Here is a man in our first illustration, with a bill for 175 units. He is shutting his shop at six o'clock. Supposing he takes it into his head to stay open until twelve, and he keeps those lights burning; he is going to have a lot of more units on his bill, but he has not increased our standing charge at all. He has made us burn a little more coal, he has called for some more incandescent lamp renewals; and it is fair he should get these extra units at the lower rate provided the business he did before six o'clock has paid his standing charges. But that is right where the shoe pinches; to try to make the man who stops at six o'clock pay his standing charges. Now, I will tell you that in the difficulty of making the six o'clock man pay his standing charges, lies the meaning of that other statement I have made more than once to you: That when the customer's whole bill is at 16 cents, I wish the customer would get off the line. If by chance that man has used enough units during the year at 16 cents to pay his standing charges, we have just swapped an old dollar for a new one, and in doing business with him we haven't made anything. Just as soon as the man begins to get some current at 4 cents he begins to be profitable to us. But if you tell a man who comes in and kicks be-cause he is charged 16 cents that he is not a profitable customer, he answers the same as the other did: He tells you that when you die you won't go to heaven. But what you tell him is the gospel fact, boys. When a man has nothing on his year's bills at 4 cents, I wish he would go to the Gas Company. But I am not going to be so uncivil as to tell him so unless I know him very well. That is exactly why I have stuck to that 16-cent rate. It is the only protection against unprofitable business. Now I am going to demonstrate that. I am going to show you where the six o'clock man comes in. I am going to do that from actual figures. This year we had, as you know, a certain load; you all know we pulled 18,000 kilowatts, including the street railway load, last Christmas week. But you don't know what the sum of all the customers' demands was because those demands do not exactly all come together. Now, I will tell you we have had some careful work done on that, and I myself have done a lot of careful work, but the closest result I have got just now may be wrong 5 to 10 per cent. Checking this result against cases of district analysis and small plant analysis, of which I have several on my hands, I am satisfied my figure for the total of the customers' demands is nearly right.

Unit Investment

On the assumption that we have a certain investment, and on the assumption that our figure for the sum of the demands of all the customers is correct, we divide the total investment by the sum of demands and we find that for every kilowatt of demand we have an investment of $420. It looks like a joke, don't it? But it is so. Listen a moment. We have an investment of over $120 per kilowatt in Delray; it takes more than a kilowatt at Delray to put a kilowatt to the uptown customer. There are losses all along the line, and there is 13 per cent going to clear waste in the motor-generators upstairs, if we wish to change alternating to direct current; and I cannot help it. Don't forget these things for a minute; a kilowatt-hour measured on the Delray switchboard does not mean a kilowatt-hour delivered to the customer. If you wanted to buy kilowatt-hours delivered at the Delray switchboard I could make you a rate that would surprise you. I got called down once by an alderman who has admitted he knows better now, because I told him that the Detroit Edison plant at Delray, which all of you understand is owned by a New York corporation, sells current at its switchboard (or was then selling current at its switchboard) to the Edison Illuminating and Peninsular Companies at 2 cents per kilowatt-hour. He figured that a 16-cent rate worked out a profit of 800 per cent, which was perfectly scandalous, he said. I told him I would like to sell a lot more current at Delray at 2 cents. I told him I would sell him all he wanted at the switchboard at 2 cents. I said to him, "Take your quart can and go down there and get all you want at that price." Then he began to think, and I guess he saw there was a whole lot of difference between going down to the switchboard and filling a quart can, and delivering the stuff up here; there were expensive cables, and then expensive underground mains, and substations and motor-generators, and all the rest of the elements which make up an electric system. The current at the switchboard is an awful lot different from the current up here both in quantity, as you know, and in quality.

To the plant at Delray costing $120 per kilowatt, we must add cost of trunk lines and tie lines to substations costing $20 per kilo-watt; substation buildings and machinery—the machinery and switchboards for a direct current substation cost $24 to $36 per kilowatt—to say nothing of cost of the building and land. And I have said nothing of the cost of conduits, 15 to 50 cents per duct foot, according to the difficulty of construction, and 4 1/2 to 7 miles long to the different substations. Then, there are the underground mains. I wonder how many of you know, some of you know of course—I . wonder if you appreciate that we have actually today a bigger reproduction value in our underground system of conduits and cables and Edison tubes, than we have in the whole Delray plant. The overhead lines are all over the town, but they do not begin to cost one-half as much as the underground system; and it would cost us to reproduce the underground system to-day more than to build a plant like the Delray plant and that is saying a big thing. Then there are service connections, transformers and meters. Now all these things pile up to this figure of $420 per kilowatt. Let me say concerning the fact that one man is served by underground wires, and another by overhead, one by direct current, and another by alternating, that. the customer has no more to say about that than he has about our plant being nearer to him than it is to some one else. We put the plant there where it is. The public of the City of Detroit required us to put these wires in this district underground; and at that time you could not put an alternating current underground. The underground system has grown to its great dimensions through public necessity, public requirements; and it is for the good of the whole City of Detroit that these wires in the business district should be underground, and it would not be fair to make the people of that district alone pay the extra price for service by underground mains, where the service is not one bit better for them than the overhead service. It is for the benefit of the whole City that the wires in the central area are underground, and the expense of that has to be carried equally by all the customers. The same as to direct current and alternating. The City required that certain wires should go underground. If we were starting in today that requirement could be met by an alternating distribution, but when we actually started in, there was nothing but a direct current system that would "stay put" underground. It is too big a change, not only for us but for our customers, to change from direct current service to alternating cur-rent, and if they were required to pay the expense of the change, they would quickly throw out their meters.

We arrive, then, at this figure, $420 per kilowatt of customer's demand. Let us look at our six o'clock customer. We had him down at 5 kilowatts. That will be a $2,100 investment. Now, in the summer time that man does not use any current at all. He may have a light burning in the back store; and maybe he will forget to turn off the light in the basement some night, and then kick like thunder about the next month's bill, but practically he uses no light in the summer time. I figured him as using light in the winter time, 35 hours a month. You take his bill and figure it carefully and you will find he only uses current about 220 hours a year. Total bill then for the year is 220 hours times 5 kilowatts equal to 1,100 kilowatt-hours. Now suppose he pays for it all at 16 cents. One hundred and seventy-six dollars, I think. Will somebody call me down if I am wrong? Total bill $176. Take a good look at that. Here is the investment: (Referring to blackboard) $420 per kilowatt or $2,100; and the bill is $176. It looks to me like 8 per cent. I have to pay taxes. Owing to the fact that our assessed valuation is not up to our investment—it is valued at a higher price than any other industry in town, however—I figure taxes at 1 1/2 per cent. Then I have interest to pay, and that is between 6 and 7 per cent per annum. I get some money at 5 per cent, but I have to guarantee that 5 per cent by getting other people to put in money on chances; and they won't take chances on 5 per cent; somewhere between 6 and 7 per cent will bring in the money into the business; but if the business is made speculative by municipal interference you can't get money for that. I will tell you there is not a manufacturing institution in Detroit that thinks it is making money if it is getting less than 12 per cent; and I have known some of them pay 100 per cent, not so very long ago, that thought they were doing moderately well. Suppose we figure our money for convenience as costing 7 per cent; it is too low, but supposing we figure it at that. Suppose we figure our taxes at 1 1/2 per cent; that is not quite enough. Then interest and taxes amount to $178.50. Who is to pay for the lamps and the coal? One hundred and seventy-six dollars' worth of business, interest and taxes alone $178.50. Depreciation left out, and my underground tubes are rusting out from year to year; the wear and tear of my machinery; the renewal of incandescent lamps—who is paying for them? Nobody. And the man wonders that we say if he takes his business to the gas company we will not be sorry.

A man whose business does not run 360 hours per annum, all at 16 cents, is not worth having on our lines. He gets even with that; when he gets past that he begins to pay us something to the good. You see the logic of that statement. Here it is again : Five kilowatts at $420 equals $2,100; interest, taxes, equals $178.50; wholesale houses shutting at half past five, nowadays, use 220 hours a year of lighting; 5 kilowatts times 220 is 1,100 kilowatt-hours a year; at 16 cents equals $176; and we are $2.50 to the bad, and I have not paid for the coal; I have not paid the payroll; I have not even paid my own salary. What am I doing business for?

A public service corporation must be willing to serve anybody for a fair price, and must offer for a fair price to do any service required. If I made a fair price to that man I would charge him 25 cents. As a matter of fact, we have an established maximum rate which we cannot raise, and we have to adjust that rate to the smallest number of yearly hours that will put us square with the game, which is 360 hours. I would far -rather make that rate 30 cents per kilowatt for 200 hours a year or say 32 cents for 180 hours a year. Then I would know that no guilty man would escape. This man that we figured at $176 would then pay us about $300 a year, and would be worth having at that, but he would be very little more than just worth having. If I could make that rate—the first rate, as I have told you, which is now 16 cents for 30 hours a month—if I could make it 32 cents for 15 hours, I would like to do it, and I would come nearer doing the right thing. And I don't know of any other way to get at it rightly; and I know I cannot do it that way so the thing has got to stick where it is. So, as I say, while we want to be civil to everybody, and we have no idea of raising the 16-cent rate, we don't particularly care for short-hour business. We have to give the Gas Company some chance for its life.

Maintenance, Depreciation, and Repairs

Now, I stuck in a note down here about depreciation. (Referring to a memorandum he had made on the board.) That is a thing about which there is a great deal of argument. To explain depreciation I will have to say something about maintenance and repairs. Those of you who are familiar with the work order numbers know the numbers that carry M and R. Now, maintenance, depreciation and repairs are three different things. We could quite well put them together in one fund, but they are, in fact, a little bit different. And it is best to separate them. Maintenance and repairs we do put together. When it is necessary to pick out our maintenance charges we can do it. Let me begin to define these things. Repairs are the expense that has to be incurred to put a damaged piece of property, a line or a building, into as good shape as it was before, or to put machinery into good running order again after it has broken down. Repairs come in after the mischief has been done. Maintenance, on the contrary, is the putting of a thing in order before it breaks down—the sort of thing Mr. Widman is so fond of doing, when he gets to rebuilding a whole line instead of replacing certain poles. Of course, he says, it will break down next year anyway and I will mend it this year. Maintenance is repairs in anticipation. A business like ours that is to serve the public must always have a maintenance fund or it will not serve the public. Suppose we would run our plant continuously until something breaks down. Supposing I-would try that plan here, that we would not make a blessed repair until something broke and the town was in the dark and we would then send word for the people to turn off their lights until day after tomorrow. Would there not be a lovely howl? Well, maintenance in a business like ours will always be a pretty large account, and inasmuch as the work is of just the same nature as work we call repairs, it is very convenient to put the two together, especially when we have such a foreman as Mr. Widman, who lets his repairs run into maintenance. It is pretty difficult to separate them anyhow. When a machine gets into the shop we fix up everything we think is likely to go wrong. It is good policy in our business. And that is one reason why we have the most reliable service in the country. (Knocks wood.)

Now, depreciation is another story. It is, in a way, the same thing, but it is another story. Depreciation is cumulative. Depreciation is maintenance, not now to be done, but to be provided for in the future. We have a new line of a dozen tubes we will say. That illustrates it perfectly. It is laid down today. Tomorrow,—no not tomorrow but right after we pay for it—it blows out three or four joints. If we did the job ourselves it would not blow out the joints, so I don't want to libel the underground department. Suppose the joints are blown out, and it was laid by contract, and we have to dig up and put in those joints again. That is repairs, right away quick. That is repairs. All the time, however, the iron tubes are rusting, and we say that in so many years from now that main has to come out. We say ten years, or fifteen years; supposing we say ten years for convenience. We say, when that main comes up it will have so much value as scrap copper. We have to repair it right along, and if we can anticipate any particular trouble we have to maintain it in advance, but we know at the end of ten years it is pretty nearly time to put that tube out of commission. Then, if we are wise, we charge up each year 10 per cent; or at least enough at compound interest so at the end of the ten years we will have enough to put in a new tube there and to take up the old one, allowing, of course, for the selling of the old one for scrap. Now, that is depreciation of the tube. You will see what I mean by calling the depreciation charge an advance charge for cumulative maintenance. The maintenance is what you can do from year to year; depreciation is the getting ready for the future so that you will have an effective tube ten years from now or have the money to pay for it. Having the money to pay for it is what we call providing a depreciation fund.

There is another thing. You know we have changed from our open arcs to closed arcs. We are changing now slowly our incandescent lamps from carbon filaments to the gem filaments. Some of these fine days we know we have to change to metallic filaments. All these things are done, not because the old practice is not good, but because the new practice is better. We have changed our engines to steam turbines. Those of you whose memory goes back fifteen years know we have had three different plants in this building, and that the former boiler house which we are now sitting in, is now in its third incarnation. All these things have meant changes in the art, have meant progress. The old stuff had ceased to be useful, not because it could not keep on doing its work as well as it ever did, but because it wasn't doing good enough work to satisfy our customers. That sort of change is called antiquation, to distinguish it from wearing out. The plant becomes old-fashioned, unsaleable, useless; and you must provide for that. You must provide for the day when you will have that which cannot be sold to customers; when they won't take the juice you make; when they won't have lamps like these; when you have to give them a different kind of service. You have to keep progressing. You must always watch for the future. That means you must be considering all the time whether your machines and your output are the best to be had today; whether there is not immediately going to be something better. Now, mind you, if you don't give the public that something better—whether that some-thing better is a better service or is the means of doing that same service cheaper—if you don't give it to them, someone else will.

If you want to stay in business, you must keep up with the procession and a little bit ahead of it.

All these things must be provided for by the depreciation charge. Now, I don't know what depreciation is going to be in the future. I wish I did. I do know this much, though, that for sixteen years the Edison depreciation cost—I am not talking about book charge—but the actual cost of depreciation was 8 per cent on the investment. Now, when I stood here and figured 7 per cent for capital, 1 1/2 per cent for taxes, if I had been figuring ten years ago I would have written on, without an instant's hesitation, 8 per cent for depreciation, and I would have said that has been so since 1886, year after year. If we are not making a sufficient depreciation reserve, we are violating the very rule with which I began this talk, that your plant must be as valuable at the end of the year as it was at the beginning of the year. We do not need 8 per cent depreciation for our modern plant. We did need it, I know, from 1886 right on until we got rid of the last plant that was in this building—until we got reconstructed, as you know we are now. I hope it will be a great deal less hereafter, 4 or 5 or 6 per cent perhaps. I hope for 5, any-way, and I am a little bit hopeful that this time ten years I will be able to say that a 4 per cent fund will take care of depreciation. But that is a hope. It is not a fact. I think 5 per cent, at least, should go in, and if we do not get 5 per cent of the value of our plant, either in a fund or back in the plant—if we do not get that out of the business, we are impairing our capital; we are putting ourselves in the hole; we are violating the first rule of business: that is, to maintain your capital—to maintain your plant.

Now, taking the round figures for convenience, a provision for taxes, interest and depreciation means we have to have 15 per cent on $420 per kilowatt over and above what it costs us to run, over and above our labor and material; we have to take care of the depreciation; we have to take care of taxes, insurance and several other things of that kind that are annual charges. That 15 per cent is about what we are taking in; if we are not taking that in, we are not safe. We have done business as low as 12 per cent, but that has been because we have been in the act of changing systems. So don't make any mistake about it. Business that is not bringing us in over and above running costs $63 per kilowatt of customers' demand is not holding up its end today.

In Conclusion

And now to sum up my discussion of this question of rates. They must be such rates, then, as will pay a profit on the investment over and above the costs. The costs must include the standing charges, distributed among the customers in the proper way; they must include depreciation distributed among the customers in the proper way, and the way to distribute standing charges and depreciation is according to the demand of the customer, and not according to kilowatt-hours—not according to units sold. That, then, is the underlying philosophy of the differential rate, the underlying equity of it. And I can tell you I have never hesitated a minute about the principle; and I have never hesitated for more than two minutes about the rate from year to year. When I have hesitated it has been because I feared I had got it a little bit low, never because I thought the rate was high.



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