The Global Power Company of the Future by Chris Trayhorn, Publisher of mThink Blue Book, November 15, 2000 The initial stages of the liberalization process currently underway across parts of the globe see individual countries separating out the traditional monopoly areas of generation, transmission, distribution, and supply and then opening up supply and generation to competition. This process provides an opportunity for companies facing limited growth prospects in their home markets to expand through international asset acquisition in newly liberalized markets. As international boundaries are swept aside and the race to become a key global power player gathers momentum, companies have some major strategic decisions to make in order to survive and deliver shareholder value. As in almost every other industry exposed to strong competitive forces, there is an increased drive to become best of breed in areas of perceived core competence. Therein lies the key to efficiency and competitiveness, profit, and ultimate success. Therefore, companies that are to succeed in the power sector will have to excel in each sector of the industry in which they have elected to remain – or be forced out by their competitors. With some likely notable exceptions, the winners will be those companies that adopt a strong horizontal focus, pursuing growth as global players specializing in different parts of the supply chain. There may be a few companies that have the size, management competence, and resources to gain from a more integrated, vertical position, but even those who seek to retain an integrated ownership structure will probably seek the strategic advantages of creating managerial and operational separation to enable them to compete in intensively competitive markets. Retail – Seller or Service Provider? As supply markets open up to new competitors and customer communication channels become ever more effective, incumbent supply companies must decide whether they are capable of building sufficient critical mass and developing the right skills to remain in the supply business. Those that choose to stay must decide whether to strive to become either a world-class retailer, creating new market propositions and exploiting new channels to market, or a world-class service provider to utility retailers. Increasing sophistication of customer demand is emerging in both industrial and domestic arenas, forcing power companies to reconsider their business strategy. Industrial customers are increasingly utilizing their newly acquired negotiating power to demand cheaper electricity, sometimes extracting double-digit discounts from their suppliers. Domestic customers are increasingly experiencing freedom of choice in other utility markets, such as telecoms, prior to the opening up of the electricity sector. This means that they are not only looking to replicate this experience across other services, but in addition are looking for the added convenience of a “bundle” of service products while at the same time demanding better standards of customer care and value-added services from their supplier. The customer in a liberalized market is spoiled for choice and will focus on price, convenience, and reliability of supply from their home services provider. New market entrants, unencumbered by past “baggage” and a traditional utility services background, will offer a broad product portfolio, possibly selling energy as a low margin “loss leader” in a portfolio product offering. Powerful global retail brands such as Wal-Mart and Virgin will make tough competitors in this now specialized retail battleground. Retailers will therefore need to focus on developing a range of services around customer needs in order to raise their sales value per customer. They will need to create premier brand recognition and excellent customer service and use technology both as a tool to aid customer service and to facilitate better management of their customer asset base. Utility companies born out of government or state-run bodies already have large customer bases and therefore have a natural initial advantage. While in the short term the ability to withstand margin pressure will be key, in the longer term only marginal differences in price will remain between retailers and branding will become increasingly important. The power and credibility of a retailer’s global brand identity, together with a reputation for excellence resulting from sustained high-quality service, will be critical for winning or retaining customers after the initial price war in a newly competitive market has died down. Does all this mean that it is necessary to retain customers to stay in the market? Those companies that have built up expertise in customer management and customer-related systems and services may choose to reduce risk by exiting the “selling” market completely. Instead they will focus on providing a customer management service to other retailers who have concentrated on building a strong brand name but have not developed the same level of service capability. Generators – Big is Best? Generators in particular see advantages from internationalizing their businesses, and a “super league” of global generating companies is emerging. These companies have sufficient mass and low enough cost of capital to participate fully in the growing international trend to liberalize power markets, acquiring local and national companies when privatization or relaxation of ownership regulations allows this to happen. Capturing economies of scale through the development of best practices in construction, trading, procurement, and technological advancement, among other areas, will enable generators to take advantage of an increasingly global market. The need to focus on cost reduction is especially important, as competition in the retail sector and the related demands of the fast developing energy trading markets will pressurize generators toward ever-cheaper power production. In addition, regulatory and environmental requirements to reduce emissions and develop sustainable energy sources (reinforced by a change in consumer requirements for “clean” energy and a shift in emphasis by shareholders to more corporate environmental responsibility) will require major R&D investment by generators and the engineering support companies. For many generating companies, particularly those in developed countries, there are limited growth prospects in their home market, and international growth is the only option for expansion. As investment opportunities in other developed countries dry up, however, global expansion will require investment in countries with heavily underdeveloped power infrastructure, which often have unstable markets. The ability to spread risk is a key driver for globalization as having a power project portfolio of sufficient scale is fundamental in order to mitigate some of the political and economic risks of investing in such countries. The recent emergence of fast-growing IPP developers creates additional competitive pressure on the existing players. IPP projects require specific expertise, particularly in key areas, such as funding, development of contractual arrangements to ensure that the project realizes a proper return, and managing local political and physical conditions. All of these areas are of fundamental importance, and companies that focus on such developments are creating a market niche. The projects often introduce the latest technologies and production efficiencies and may become benchmark low-cost producers in growing markets. Larger traditional generators that have set up their own IPP companies, and the investment in independent power projects by some oil companies that have large cash and raw material resources, provide some signposts for the future in terms of the competitiveness in this area. The traditional roles of a generator, from ownership of the generating station to maintenance of assets, operation of the station, and the trading of the power output, will start to disaggregate as power companies assess where their expertise lies. One result could be an international tolling station operator that is engaged by the owners of power stations (e.g., banks) to operate those assets while outsourcing the maintenance of specific equipment to the original manufacturers and the trading of the station power-sourcing and output to various trading organizations. Trading – Outside the Capabilities of the Traditional Power Companies? New trading markets will open up as liberalization of power markets moves electricity and gas trading toward a more liquid market. The number of pure energy traders will increase as gas and electricity become traded in the same way as other commodities such as metals and foreign exchange. Trading is a specialist skill, and experiences from other commodity and financial markets show the potentially devastating effects of “getting it wrong.” Already, some utilities that have little of their own production capacity have encountered major difficulties with forecasting demand during extreme weather conditions, thus having to procure power at high prices while their customers have fixed price deals. This has led to a cautious approach to trading and the emergence of three clear types of operation. First, there are the portfolio managers whose job is essentially to operate robust risk management strategies, hedging business unit needs. The second are asset-based traders with access to plant data and with a superior forward price model. They will leverage a physical position, and the trades may become larger and more sophisticated as systems and trading skills become more advanced. The advent of liquid markets will open up a role for a third type of trader, the pure trader, who will compete on the basis of trading skills and knowledge developed in other markets and will be likely to build business through innovation in deal-making. Some traditional power companies have developed highly-skilled trading departments, conducting high-volume trading operations that have expanded beyond a pure risk management role. In an increasingly complex and geographically diverse energy trading market, these companies may choose to concentrate on exploiting their experience and consolidating a position as global power traders in one or more geographical markets, with the potentially high margins that accompany success in this area. Their market knowledge, together with their asset backing, good credit ratings for the large incumbents, and the likelihood of imperfect markets for the short term at least, will make it harder for the pure trader to flourish in competition with these operators. Even if power companies choose to focus in another area of the power industry and do not adopt speculative positions, they will still have to have access to skilled traders who can assist them in managing their natural generation or retail risk position. Excellence in risk management processes and the quality and experience of their traders are essential ingredients for market participants if they are to create success in an exchange based market. With the potential for development of trading markets across borders, companies cannot afford only to focus on traditional territorial markets and keep abreast of what will be a challenging and fast developing area. Asset Managers/Network Operators – One and the Same? Since a local distribution network constitutes a natural monopoly, a liberalized power market is likely to retain some level of revenue regulation for distributors. The extent and structure of regulatory control will determine the attractiveness for investment in distribution assets. While some governments may act as a “Customer’s Champion” and adopt a fairly hands-on regulatory role, others will choose to appoint an independent “Refereeing” body to ensure a level playing field. Maintaining the status quo will lead distribution companies down the path of declining shareholder returns, as strategies need to be developed to maintain and grow profits in the face of regulatory pressure, which by definition is there to ensure that customers are protected. In the face of high fixed maintenance costs and regulated revenues, network managers will have to explore new avenues of operation in order to succeed. The fundamental question for such businesses is whether owning and operating a network have to be combined or whether to separate such functions. The answer will require a decision as to whether the core competencies of the company lie in dealing with an electricity or gas network, or within infrastructure management itself. Many traditional network managers will grow their revenues by acquiring or running other infrastructure maintenance businesses such as telecom network maintenance or by creating new value-adding services such as joint metering services for multi-utility clients. They will need to find ways of working their assets harder and more creatively, utilizing different organizational structures, and managing and developing new management outlooks and skills. Management of networks is increasingly likely to be exercized on a “virtual” basis (i.e., managing and controlling assets without actually owning them). Harnessing E-Business Harnessing e-business will become an essential success criterion for utilities, driving the speed of the industry’s transformation. As with all new paradigms, there are both gains to be embraced and risks to be managed. What is clear is that this new enabling technology cannot be ignored and all businesses need to develop their thinking as to how to take advantage of new ideas and, moreover, to understand the risks that these pose to a traditional business. Customers will become rapidly accustomed to choosing deals through the Internet and will be quick to grasp online utility offers. New entrants are already using this as an avenue to develop customer access and are taking advantage of the low entry cost of an online operation to combine product offerings as part of their “proposition” to the market. Increased access to information through these non-traditional sources will help change the supplier/customer relationship as comparing offers is simple and the methodology and speed of switching suppliers is simplified. Business-to-business transactions are of even more import to the supply companies as commercial enterprises will be even faster at grasping the opportunities offered by e-business, adopting its use in the management of their supply chain. E-business is delivering a more effective platform for energy trading which, for the first time, is seeing gas and electricity traded like goods in other commodity markets. As for the customer arena, the low set-up cost is encouraging new entrants to the trading scene, though for a time they will be hampered by their own size and by related credit issues. The advantages of using new technologies to enhance basic processes at low cost are significant. From online customer billing to remote meter-reading input by customers, through adopting e-procurement methodologies directly or through new portals, utilities will be able to benefit from improved business processes. At the more strategic level, the use of technology to facilitate the development of “virtual” businesses across geographies will favor those companies that embrace them first. The impact of e-business cannot be ignored by the utilities. Companies have no choice but to develop their responses and in doing so will need to be imaginative and flexible as the one sure thing is that the ultimate development of e-business in the power markets will not fit any of today’s definitions. Where Now? Choosing their final destination on the new global power stage will require a rigorous evaluation by power companies of where value will lie, the scale at which they will need to operate, their current core competencies, and how far these factors take them toward the key capabilities that they will require. One thing is certain – the industry transformation is gaining momentum. One only has to look at the emerging (and dramatically changed) pattern of ownership in countries where liberalization has been challenging old structures to see that complacency is not an option. Changes which have taken place slowly over the past decade in liberalized countries such as Norway and the U.K. are gathering pace as reform spreads throughout the rest of the European Union, Argentina, South America, the United States, and beyond. The need for size to compete, new skills to stay ahead, and a focus on value creating elements of the business, will change the industry out of all recognition. It is unlikely that many global power companies will be able to develop and sustain long-term excellence in all of the segments of the industry value chain. Increasingly, the global power markets will see the development of functional disaggregation and consolidation within functions, as companies focus on building their chosen specialties. Radical choices have to be made. Companies failing to deploy radical strategies now will be swept away, either by the forces of competition or by those that implement rapid and innovative changes. Filed under: White Papers Tagged under: Utilities About the Author Chris Trayhorn, Publisher of mThink Blue Book Chris Trayhorn is the Chairman of the Performance Marketing Industry Blue Ribbon Panel and the CEO of mThink.com, a leading online and content marketing agency. He has founded four successful marketing companies in London and San Francisco in the last 15 years, and is currently the founder and publisher of Revenue+Performance magazine, the magazine of the performance marketing industry since 2002.