A New Taxonomy

The forces of change shaping the energy industry will combine with continued
regulatory pressure to further fragment the industry and bring about a
new energy taxonomy. As the future energy industry fragments, enterprises
will focus on one or more parts of the new value chain (see Figure 1).

Figure 1
The New Energy Industry Taxonomy

An incumbent may choose to perform one or more of the new energy value
chain roles, depending on perceived core competencies, risk appetite,
and preferred market focus (consumer segments served, channel-mix adopted,
products and services offered and regional/national/global concentration).
They will need to unbundle, then restructure, their activities to ensure
single-minded focus on their chosen future business model. The depth of
specialist competencies required to meet consumer expectations and compete
successfully will require incumbents to re-invent themselves in a revolutionary,
rather than evolutionary, manner.

Specialization and Focus

Traditionally a vertically-integrated monopoly, the energy industry will
increasingly expand horizontally as players specialize and focus. The
demands of the new retailing market, combined with the benefits of specializing,
will drive the separation of retailing activities from other parts of
the new value chain. Competition will force those companies choosing to
operate in multiple parts of the value chain to become “best in class”
in each part.

Energy retailing will converge with other forms of retailing and will
become much more competitive as the marketing and Customer Relationship
Management skills of major retailers are brought to bear on the energy
market. Hence, incumbents will need to think about the strategic direction
of unbundled retail activities such as:

• Front office – Customer Relationship Management and energy product
  building; and

• Back office – customer contact service provision, billing service
  provision, metering data provision, and meter ownership and maintenance
  (see Figure 1).

In the future, specialist service providers will provide back-office
services to the front-office players. Germany has seen the emergence of
specialist service providers such as Techem (metering and billing) and
Brunata Metrona (district heating, metering, and billing). In the Nordic
market there are, for example, Etrem and Enermet. The former is owned
by inter alia, Fortum, Birka Energi, and Trondheim Energiverk and provides
metering, billing, and data transmission services. The latter, also partly
owned by Fortum, provides meters, terminal units, comprehensive metering,
remote reading, and load management services.

In effect, competition and the benefits of specialization will drive
the separation of retailing and back-office service provision. Some incumbents
may choose to continue to provide both office functions, but, at the very
least, these activities will be performed by separately managed profit
centers within the single corporate structure. Increasingly in the future,
however, they will be outsourced to specialists.

The benefits of specialization coupled with the different cultures, capabilities,
and skills required of a successful retailer compared to those required
to be a successful network service provider, will also inexorably drive
the separation of these two. For example:

• In Norway, Oslo Energi AS, the largest electricity company in Norway,
  was split into Oslo Energi Holding AS and Viken Energinett AS in 1996.
  The former covers the contestable areas of sales and production with
  about 300,000 customers. In 1999, 49 percent of Oslo Energi AS was
  sold to Sweden’s Vattenfall. The latter company, Viken Energinett,
  covers the regulated monopoly areas of transmission, distribution,
  and district heating and has about 380,000 grid customers. In 1999,
  the company merged with EAB, purchased 12 percent of Akershus Nett,
  and transferred 25 percent ownership to Hafslund – all distributors
  in Norway’s east. Hence, distribution in the eastern region of Norway
  is specializing and consolidating horizontally.

• In Australia, United Energy, Shell Australia and Woodside Petroleum
  have created Pulse Energy into which United Energy will tip its retail
  arm but continue to run its local electricity and gas networks (AFR
  9/3/2000).

Some incumbents will elect to continue to operate across more than one
part of the value chain. Ever-increasing competition will demand that
these companies become “best in class” in each part of the new value chain
in which they continue to participate. Each line of business may be established
as an independent unit, perhaps even a separate profit center, within
the overall corporate structure. (See Figure 2.)

Figure 2
A Possible Future Integrated Model

Segmentation

Successful future retailers will be proficient at market segmentation
and identification of profitable segments. Retailers choosing to serve
the large end-user segment will provide specialist services tailored to
the needs of geographically dispersed, multi-site customers. In the mass
market, convergence is likely to see new entrants to energy retailing,
including those with strong brands, proven Customer Relationship Management
skills and advanced Internet applications. Partnering will be used to
build coherent sets of offerings. Margins are likely to be low.

Energy retailing embraces a long list of end-user types – large volume
industrial users, commercial buildings, supermarkets, hospitals, small
businesses, government departments, and residential consumers, to name
a few. When other parameters such as demographics, psychographics, and
profitability are also considered, segmentation possibilities seem endless.
At the highest level, however, some retailers will focus on large industrial
and commercial consumers and others on the mass market.

Large Industrial and Commercial Consumers

For these end users, energy as part of their cost of goods sold ranges
from just a few percent to well into the 10 to 20 percent range. Wherever
consumers may sit in this range, the sourcing of cheaper energy that meets
their security and quality needs is just too important to their own competitiveness
and profits to procrastinate or hold to traditional loyalties.

In this segment, the popular practice of engaging an energy-purchasing
specialist and using a tendering process – potentially e-enabled – can
promote a largely price-driven approach to energy purchasing.

Specialist services will be required to meet the diverse needs of these
consumers. Some larger industrial sites will have access to on-site or
co-site generation. Others possess the infrastructure for dual fuel capability.
Some are moving to purchasing process steam from an outsourced facilities
manager rather than purchase source fuel themselves.

For risk management reasons, generators and energy traders will also
want to retail to this group. For example, generators in New Zealand and
the U.K. have been reconstructing the energy value chain by buying retail
businesses.

Retailers choosing to operate in this business-to-business market segment
will develop national, international, or global footprints and provide
energy products and energy management services customized to individual
customers. They will be able to aggregate the energy needs of companies
with multiple, geographically dispersed sites and will provide specialized
services such as consolidated billing, dual fuel billing, risk mitigation
products and consulting services to improve energy efficiency. They are
likely to acquire the largest consumers of this segment by providing energy
products and services beyond the capabilities of the smaller incumbent
retailers.

In Germany, Euro-power has focused on this market segment. VASA, a joint
venture between Vattenfall and a German investor, has focused on supplying
municipalities with electricity for on-selling. HEW pursues the aggregated
loads of multi-site consumers and buying groups.

Mass Market Consumers

A range of new players is likely to enter the mass-market energy-retailing
scene. Incumbents will compete against major brand “bricks and mortar”
retailers from other markets and also against e-tailers. Examples of potential
national retailers in the U.K. include Tesco and Sainsbury and in Australia,
Coles Myer, and Woolworths. Global examples include Shell as a major brand
competitor and Yahoo!, Amazon, and AOL as Web-based retailers. These new
entrants will compete on value, brand equity, and the ability to deliver
through channels of choice.

Partnering, in the form of joint ventures or strategic alliances, is
likely to be a popular strategy. Very few retailers, if any, will have
the ability to compete successfully across all the products and services
of future market spaces. Examples of potential horizon-tally-integrated
mass market retailers offering coherent product and service bundles include:

• Utility home products and services com-panies (energy, telecom, home
  security);

• Broad energy companies (energy, gasoline, credit cards, loyalty programs,
  fast food);

• Financial institutions (energy, credit cards, financial products,
  retail products, telecom, banking); and

• Major brand retailers (energy, gasoline, loyalty programs, financial
  products, retail products, telecom, banking).

For risk management reasons, generators will also enter mass-market retailing.
In Germany, PreussenElektra and Bayernwerk now retail to domestic consumers.
Before deregulation, they wholesaled to regional and municipal companies.
PreussenElektra has launched ElektraDirekt to focus on domestic consumers.
Bayerwerk has introduced a family of products (PowerPrivate, PowerFamily,
AquaPower, and SunPower) targeted directly at residential consumers.

The gross margin earned in the mass market is likely to be low, particularly
where there is an over-supply situation, due to intense competition to
win and retain customers. Some new entrant retailers may offer energy
products at a loss to aggressively acquire new customers and at the same
time build a stronger, wider relationship with their current customers.
Significant economies of scale accrue to companies like EdF and Centrica
who already have customer bases numbering tens of millions of households.
Leveraging scale and scope to drive down costs to serve, costs to acquire,
and costs to retain, as well as for competitive advantage and differentiation,
will be critical success factors.

Unlike many incumbents, today’s successful major mass marketers have
already mastered a range of essential competencies. These include:

• Strong brands supported by effective marketing to large customer
  bases;

• Marketing strategies targeted to sharply defined key segments;

• IT systems, revenue management, and customer service capabilities
  that are cost-effective and flexible;

• Coherent product bundles, service offers, and pricing delivered with
  the help of a range of partners;

• Exceptional value propositions;

• Flexibility and responsiveness;

• Strong customer touchpoints; and

• Increasing provision of self-fulfillment functionality for customers.

Existing energy retailers may not have the skills and capabilities necessary
to “go it alone.” They will, however, be sought after as alliance partners
by new entrants.

Figure 3, “The Future Energy Retailing Industry Structure,” maps the
new market structure that is likely to emerge. A range of new retailers
will join incumbents. Traditional channels will give ground to e-tailing,
partnerships with other brands, affiliation marketing, brokers, and direct
sales.

Figure 3
The Future Energy Retailing Industry Structure

The Rise of E-tailing

Retailing barriers to entry are being brought tumbling down by the Internet
and new Web-enabled technologies.

The Internet enables carefully targeted communications and, when combined
with e-business, provides the platform for serving markets of one. Dynamic
customer segmentation is easier and faster. Products and services may
be modified, rearranged, and tailored at will. Innovation is almost instantaneous.
Far more customer information can be gathered and analyzed in a shorter
time. New energy retailing processes, systems, behaviors, and values are
needed in this environment, and they are vastly different to traditional
requirements. The adjustment will not be easy, and partnering may be the
optimumsolution for many incumbents to succeed as e-tailers.

Future e-tailers may be:

• Incumbents who have reinvented themselves through specialization
  and focus. In Australia, AGL has flagged their intention to develop
  their Internet and e-business capabilities to leverage their expanding
  customer base in Australia and New Zealand (AFR 3/3/2000).

• New entrants with well established brands. The Australian Centre
  for Retail Studies states that almost 90 percent of retailers with
  revenues of more than $600 million claim to have an e-business strategy
  (AFR 26/11/99).

• From other industries developing strong Internet competencies, for
  example banks and financial institutions.

• New, smaller enterprises with an effective website and a new way
  to sign up customers, for example, enermetrix.com and nexusenergy.com
  in the U.S. enermetrix.com offers savings on electricity and gas purchases
  of between 10 percent and 20 percent. The company helps customers
  define their energy contract requirements, and then over 40 suppliers
  compete in an auction for the load. enermetrix.com staff manages the
  contract documents and the purchase on behalf of customers. nexusenergy.com
  effectively extends wholesale prices into the retail market by aggregating
  mass-market customers up to wholesale suppliers.

E-tailers will race to attract and keep customers and, in the absence
of differentiation, discounting will be a powerful weapon in the battle
to win customers. The Internet enables marketing, sales, and transaction
costs to be significantly reduced, thus changing the traditional cost
effectiveness equations associated with acquiring and retaining customers.
There is the very real possibility that e-tailers will use energy as a
loss leader. At the very least, they will encourage consumers to shop
around. The attraction of lower prices is powerful and can significantly
lessen the strength of brands and customer loyalty among price-sensitive
consumers. Under these circumstances owning the customer relationship
is difficult.

Looking beyond the immediate horizon, the rise of the Internet could
encourage the emergence of specialist energy traders appealing direct
to large end users with a single-minded lowest price offer, thus competing
directly with retailers. The Internet will also simplify the process of
forming and transacting with buying groups, especially those with large
numbers. The low cost platform of e-business will be especially effective
with residential and small business buying groups because the cost of
acquiring these low volume consumers is usually a barrier to competition.

In Conclusion

The future for today’s energy retailers will be very different. All will
face strong cost pressures and the prospect of low returns. They will
focus more on segmentation and implement marketing strategies tailored
to segments.

The mass market will segment into Internet users, other high-income consumers,
and the fuel poor. Competitive pressures from new entrants will be felt
as multi-product portals serve Internet customers, major brand retailers
compete for the other high income “cherries” and the fuel poor continue
to attract regulatory controls. Retailers serving the large industrial
and commercial segment will operate nationally and provide energy product
and service value propositions tailored to individual multi-site customers.

Retailing activities will separate from back-office service provision
as well as from network service provision. Retail returns on electricity
will probably be low, particularly if used as a loss leader by multi-product
new entrants looking to maximize the lifetime value of their customers.

New forms of energy retailing, leveraging broader channel mixes, are
being created. Together with ongoing change this will create a risky business
environment. To be successful, energy retailers should develop capabilities
to:

• Gain a deep understanding of consumer needs as the basis for dynamic
  segmentation;

• Select profitable target markets and their preferred channel mix;

• Go to market with unique value propositions that create consumer
  expectations and shape end user needs;

• Manage service delivery to meet customer needs;

• Provide the infrastructure to cost-effectively support those needs;

• Earn a profit by fulfilling those needs.