Innovation Does Matter

Innovation may be one of the most overused terms among strategists, used interchangeably
with technology improvements, process changes and many other tactical notions.
This has devalued the concept of innovation, and made it seem common, not distinctive.
For those of us who thrive on quantitative data to make key decisions, innovation
has become suspect – used too often to justify too little. At best, we see that
results are difficult to measure. At worst, we hear colleagues cloak proposals
with the term “strategic,” often to justify an investment with the hope of not
having to quantify the results.

As a result, developing a corporate commitment to innovation has become difficult
for the electric and gas utilities industry. With the other pressures facing
executives, it is difficult to focus significant resources on innovation. This
is a sad state of affairs, given the industry’s past role as a technology leader.
As the industry tackles its next set of challenges, innovation needs to come
back to the forefront. To do so, the industry must encourage the development
of a culture of innovation, similar to that found in other industries.

Industry Forces

The electric and gas utilities industry faces complex financial, market and
operational challenges. Heightened financial pressures continue to plague the
industry as companies strive to balance adequate shareholder returns with reasonable
rates in a period of intense infrastructure investment and rising fuel prices.
Multibillion-dollar capital requirements over the next decade will put stress
on the traditional financial strength of the industry. Meeting those needs represents
a significant challenge. Companies will continue to struggle to provide investors
with growing returns while keeping their promise to focus on their core business.

The first wave of restructured states are exiting their transition periods,
which will test policymakers’ resolve regarding the benefits of competitive
markets – and their willingness to provide structures that support them. This,
coupled with rising fuel prices, will have a significant impact on consumers’
appetite for competition; restructuring was a good idea while consumers enjoyed
guarantees and competitors offered price reductions. A lack of stability in
the wholesale markets compounds the overall issue, especially as the industry
faces significant increases in electric demand over the next two decades.

Additionally, operational issues loom in the forefront of senior executives’
minds. Reliability has rarely been more important. The blackouts underscored
this issue for senior executives but, even more so, for customers. Increasing
numbers of industrial and commercial customers have determined that they cannot
rely on utilities to provide the type of reliability such businesses require.

Why Innovation Matters

Why should a company care about innovation? Arguably, capital constraints and
higher priority investments might seem more important. Putting innovation into
the equation has the potential to divert limited resources, both financial and
human, from the key issues at hand. While this view seems like a valid short-term
answer, it fails to achieve the longterm vision. In fact, innovation matters
now more than ever as there may be no other way for the industry to find its
way to a long-term solution.

It is important to recognize the results of past innovation. For example, innovation
has resulted in exponential efficiency gains for the generation sector. Manufacturers
have produced equipment with efficiency ratings not thought possible just a
few decades ago. The smart grid has started to move from concept to reality.
Innovations in grid technologies and broadband over power lines (BPL) have begun
to make this possible. These are a few key examples that demonstrate the promise
of innovation.

Why is technological and product innovation a key feature of so many other
industries but lacking in the utility business? The electric and gas utilities
industry has not made enough of a concerted effort to capitalize on the overall
possibilities enabled by innovation. While deregulation has brought more pricing
and product options, there has been little of the innovation seen in other industries.

To change this, the industry needs to make fundamental changes in its view
of innovation and develop a culture of innovation throughout the entire industry
ecosystem. Companies can no longer rely strictly on vendors for the investments.
Vendors can no longer hold back on innovation because the “industry is not asking
for it.” Regulators need to stop punishing utilities for well-thought-out and
sound decisions that did not succeed. Consumer advocates need to consider what
customers really value rather than replay the tired regulatory “evil utility
gouging customers” tune when real electric prices are far lower than they were
20 years ago.

Rewarding, Not Ordering

Utilities must embrace innovation as an integral concept, not one left to a
small group within the company that controls a research and development (R&D)
budget. Companies cannot order innovation, only foster it. Transforming from
an operationally focused, risk-averse culture to one that rewards innovative
ideas represents a dramatic change, uncharacteristic of much of the industry
over the past few years.

The first step in this journey centers on leadership; the “tone at the top”
could be the most important component of this transformation. Senior leaders
need to embrace innovation and continually stress its importance. This means
accepting both successes and failures. This concept is difficult to accept in
an industry that has written off more than $40 billion of unsuccessful investments
over the past two decades, few of which resulted from attempts at technology
or product innovation.

Companies need to adjust the strategic planning process to generate, incubate
and implement innovative ideas. Executives need to debate ideas from a strategic
and quantitative perspective, allowing the best ideas to move forward. This
also will help a company understand which concepts need incubation over the
next three to five years and require specific funding from a financial and human
capital perspective. Adding a specific incubation function to the company will
provide proper focus and attention on the best nascent ideas. Shell’s Game-Changer
process is an excellent example of an innovation-friendly process woven into
the R&D infrastructure that has delivered results.

The industry also needs a fundamental change to the overall capital allocation
practices and processes within the company. Traditional practices do little
to foster innovative ideas and investments. While capital allocation processes
have become more sophisticated in the past decade, they do not adequately account
for the need for innovation investments. Adopting a portfolio approach that
adequately weights the value of innovation is a step in the right direction.
However, companies need to assign a percentage of the capital budget to innovation.
Allocating at least 10 percent of the capital budget to innovative investments
is a good starting point.

This does not mean discarding the financial and economic analysis normally
required for capital investments. While rigorous innovation may sound like an
oxymoron, rigorous quantitative analysis represents a critical factor in not
repeating investment mistakes of the past three decades. This analysis needs
to be sophisticated enough to account for the various technical, operational
and regulatory risks associated with these types of investments. A simple business
case that relies on a single return on investment figure will not be sufficient
to analyze potential investments.

Industry Ecosystem

Other members of the industry need to participate in the drive for innovation.
For example, regulators need to embrace the idea and be willing to modify standard
ratemaking to motivate innovation.

The Energy Policy Act of 2005 has some specific incentives for innovation relating
to real-time pricing, smart meters, transmission infrastructure, nuclear power,
clean coal and renewables. They mainly come in the form of financial incentives
and a push for adoption of standards. While this is a start, state regulatory
agencies play a significant role in the process. Many believe in the concept,
but few have been willing to adopt mechanisms that both motivate and reward
utilities on the cutting edge of innovation. California’s push toward automated
metering is a notable example of how a regulatory commission is willing to push
innovation. Regulators’ current assumptions that customers are unwilling to
pay more for innovative services is belied by the panoply of products and services
in telecommunications. Price is important, but not the only consideration that
customers factor in to purchasing decisions.

Vendors have a wealth of intellectual capital, much of which focuses on industries
more willing to take advantage of innovation. While we wish vendors would believe
in the industry’s appetite for innovation, most have been disappointed. Therefore,
the utility industry must convince vendors to focus as much effort on the utility
industry as they do on other industries.


Future of Innovation

A culture of innovation will fuel the necessary growth and efficiencies. If
the industry players make this a priority, we will see a great exploitation
of process and technological innovations over the next decade. Some of these
are well under way but need further study, while others are at a more nascent
phase of the development cycle.

Key areas of innovation are likely to be:

  • Workforce: Processes and technologies that transform the technical worker
    into a knowledge worker;

  • Generation: Technologies that provide more than 20 percent gains in the
    efficiencies of the existing generation resources;

  • Clean Coal: A “zero emission” coal-generating station;
  • Coal Gasification: Technologies that solve the problem of increased gas-fired
    generation with a decreasing supply and increased price of natural gas;

  • Integrated Home Premise: Technologies that provide seamless integration
    of utility demand management, communication, entertainment, etc., including
    the use of BPL; and

  • Reliability: Distribution and transmission technologies that exponentially
    increase reliability factors in a cost-effective manner.

This is by no means a comprehensive list, but it represents some key
areas of innovation that hold the greatest promise. Business will drive all
of these innovations (Figure 1).

Conclusion

Traditionally, innovation fulfills two critical needs: top-line growth and
improved efficiency. For the utility industry, the latter will be the most significant
over the next decade.

Over the next decade, the utility industry needs to become
known for its innovative developments and leadership in this area, not for being
the laggard that was unwilling to embrace change.