Formative evaluation of electricity distribution utilities using data envelopment analysis

The use of Data Envelopment Analysis (DEA) in the electricity distribution sector has been prolific in the number of papers published in research journals. However, while numerous studies have been documented, they have mostly been summative. Their aim has been predominantly descriptive and classificatory. This paper argues that evaluations of a formative nature are more effective than summative studies in promoting a better understanding of the structures and processes of electricity distribution utilities and, consequently, are more appropriate to contribute to performance improvement. To illustrate the use of DEA for formative evaluation, and highlight some of the difficulties of using DEA in practice, this paper compares the cost‐efficiency of the Portuguese electricity distribution companies from 2002 to 2006. A dynamic analysis using Malmquist Indices is also conducted in order to evaluate the changes in productivity over this period. Our analysis shows that the application of DEA for formative purposes meets some difficulties. In particular it shows that while the modelling of productivity/efficiency scores using DEA is relatively straightforward, it is comparatively more difficult to develop models that are economically valid and that produce results with face validity. On the basis of the insights derived from this analysis, the paper provides some recommendations regarding the successful application of DEA for performance improvement.