[1] The system is intended to provide incentives for efficiency savings, as any savings above the productivity factor (this predicted rate of efficiency is commonly called the X-factor) can be passed on to shareholders, at least until the revenue caps are next reviewed (usually every five years).
A key part of the system is that the X-factor is based not only a firm's past performance, but on the performance of other firms in the industry: X is intended to be a proxy for a competitive market, in industries which are natural monopolies.
Second, the X-factor is intended to capture the difference between the operator and the average firm in the economy with respect to inflation in input prices and changes in productivity.
Some regulators choose a general measure of inflation, such as a gross national product price index.
In these cases, the X-factor represents the difference between the operator and the average retail (or wholesale) firm.