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.