Information Technology and the New Energy Industry Model by Chris Trayhorn, Publisher of mThink Blue Book, November 15, 2000 For the past 50 years, the utility industry landscape has been dominated by the vertically-integrated business model, with companies owning and operating most or all elements of the energy value chain within certain monopoly territories and within certain business segments. During the past 10 years, this model has begun to “dis-integrate” into separate lines of business (LOBs), some of which remain regulated and others becoming unregulated, but typically under a holding company umbrella. However, this model is transitional and is, at least partially, an attempt to extend the life of the old vertically-integrated utility model and to resist the emerging new energy industry paradigm. We believe the transitional model will dominate for the next five years. The emerging value chain model will begin gaining acceptance in the 2002-2005 timeframe and become the dominant model beyond 2005. Five Major LOBs This emerging model is characterized by five major LOBs that span the entire energy value chain (see Figure 1): Extraction of natural resources (e.g., oil, gas, coal) Processing of resources into energy products (e.g., power generation, oil refining) Wholesale marketing and trading Delivery of energy via network infrastructure (e.g., transmission and distribution) Retail marketing of energy products to end use consumers Figure 1 The New Energy Industry Model See larger image Each LOB can be owned and operated as a separate business or can be combined or grouped under a single holding company to mitigate risk. Additionally, each LOB can be associated with other related non-energy businesses, which provide a benchmark for business performance, a route to business expansion, and a gateway through which new competitors may enter. For example, the energy processing LOB (e.g., power generation, oil refining) can be associated with other process manufacturing businesses such as chemicals or water treatment. Increasingly, power generation executives are asking which processes and technology have proven most effective in deregulated process manufacturing markets. Of the five LOBs, only the delivery business (e.g., transmission and distribution) will remain as a regulated utility. All other LOBs will operate as competitive businesses. Since technology strategy is profoundly impacted by market structure, we predict a significant shift in energy industry technology strategy during the next five years (see Figure 2). Under the old vertically-integrated utility model, technology strategy focused on transaction efficiency (in an effort to drive down costs), rates of change were determined by the regulator, and the regulator/ratepayers shared technology investment risk. In the new energy industry model, competitive intelligence will dominate transaction efficiency (but will not eliminate it), cycle times will be determined by the markets, and technology investment risk will be borne by shareholders. Figure 2 Impact on technology strategy How are Market Leaders Responding? Energy market leaders, both those emerging from the regulated utility market and those entering from competitive markets, are integrating business and technology strategy as a primary goal. We believe that success in integrating business and technology strategy has become an industry best practice and will become a differentiator in the market. However, we are also finding that executive commitment is necessary for this integration, and this is yet another cultural shift for the industry to navigate. This is forcing companies to re-evaluate their source of IT advantage – is it transactional efficiency or is it competitive and operating intelligence? Those focused on competitive and operating intelligence are building IT knowledge in areas that will be required under the new energy market structure. Whether competition arrives on time is not the issue. Market leaders are positioning technology to take advantage of performance-based regulation and/or competition, whichever comes first. Pipes and Wires: Transitioning to the New Model As part of the energy industry evolution to the value chain model, pipes and wires businesses are transitioning from a traditional utility structure to a virtual business structure. This transition is forcing pipes and wires organizations to abandon traditional business models (vertical integration, local service territory) and move toward a highly-outsourced virtual business model with global operations (see Figure 3). We believe this transition will have dramatic IT investment implications during 2000-2004, particularly in IT organization, outsourcing, architecture, and applications. Figure 3 Pipes and Wires Business Models During the transition (a time of uncertainty and change), integrating business and IT strategy, and minimizing IT cost in the context of business strategy will be critical success factors. Additionally, the use of internal shared services by IT organizations will be challenged, accelerating the growth of separate shared services IT companies. Outsourcing will move beyond energy network infrastructure-related services (e.g., design, construction, maintenance) to encompass a wide range of IT, Customer Relationship Management (CRM), and revenue cycle (e.g., metering, billing, settlement) services. Development of an enterprise-wide technical architecture (EWTA) to support the business goals (e.g., reduce costs, increase reliability and quality) yet provide for adaptability, scalability, and increasing external communications will also be a differentiator for successful companies. Finally, we expect the current collection of applications (e.g., GIS, work management, distribution management, etc.) used by pipes and wires businesses to evolve into an integrated distribution resource management system. IT Organization for Pipes and Wires IT governance will be a critical success factor for pipes and wires companies navigating this business transition. We believe CIOs will reshape their existing IT councils into enterprise architecture groups in an effort to improve the integration of business and technology strategies. Additionally, the minimization of basic IT service costs will be critical to the pipes and wires lines of business. Refurbishing the IT council will provide an important element of governance in reconciling the enterprise demand of IT operating excellence, while delivering customized IT service to various LOBs. For pipes and wires organizations operating as part of a larger energy holding company and served by a corporate IT shared services group, we believe these shared services IT structures will run into resistance as regulators grapple with a mixed market where some LOBs are regulated and others are unregulated. By 2004, we predict that moving the IT organization into a separate, unregulated IT services company will be the norm. Restructuring the Energy Delivery System New forms of competition on the supply side of the energy industry is driving discussion regarding restructuring of the delivery function as well. The development of distributed generation technologies and moves by aggressive energy retailers will be the greatest influence on these activities. As experience is gained in the competitive electric and gas supply markets, regulators and industry leaders are now turning their attention to the possible restructuring of the energy delivery system. This shift is driven partly by the advent of new technologies such as distributed generation (DG) and partly by the early adopters of supply competition who are now looking to the distribution arena for innovation and change. The information requirements necessary to accommodate and enable the types of changes being envisioned will require significant advances in IT deployment, specifically in the areas of communications, metering, and control. Initially, these changes will manifest themselves as enhancements to existing energy management (EMS), supervisory control and data acquisition (SCADA), and automated meter reading (AMR) systems. Longer term, we predict the development of an Internet-based communications network that parallels the topology of the energy delivery network. The Competitive “Push” for Distributed Generation Distributed generation offers opportunities for pipes and wires businesses to increase the value of their regulated delivery networks in local energy markets. This notion is premised on the first-mover advantage to those who create physical and IT infrastructures optimal for DG development. But this first-mover advantage does not translate to the pipes and wires businesses being the logical channel to the consumer. Pipes and wires businesses, or their affiliates, need to ally with distributors of DG products and services to exploit that market. Currently, however, these same DG vendors are instead facing impediments that pipes and wires businesses are erecting to thwart the deployment of DG over their systems. DG proponents are clamoring for open access to the retail wires, modeled after federal transmission open access. Competitive retail electric suppliers are also complaining about the pipes and wires companies’ ability to provide a preference to their own, or their affiliates, supply. The notion that is being advanced from both camps is that the pipes and wires should be truly open and service should be provided on a comparable basis to any competitors – that is comparable to the terms and conditions that the company offers to itself or its affiliates. In addition, pipes and wires companies are being pressured to remove other impediments at the retail level, such as excessive backup and standby service requirements, and restrictive interconnection standards. Energy FAQ Energy industry business and IT leaders are currently asking themselves three important questions: What do we need to do to survive? What do we need to do to be competitive? What do we want to be when we grow up? META Group research indicates that 10 percent of existing energy utilities are in denial – they believe that the traditional regulated business model will return and that survival depends on waiting out the “experiment” with competition. Seventy percent are struggling to define a future state of the industry, and 20 percent have a vision of the future and coherent programs in place to migrate the business. However, we believe that most of the business and IT investments in energy utilities today can be characterized as related to survival. The real competitive initiatives are coming from outside the traditional utility space, either from the oil & gas majors (e.g., Enron, Shell, etc.) or from Internet startups (e.g., Utility.com, Enermetrix.com, HoustonStreet.com). Regardless, industry leaders must realize that technology strategy is an important component of the answer to each of the three questions. Why is Technology Important? Technology is important in the energy industry for the same reasons it is important in other industries – it is the primary source of business process automation and cost management; it is the desired transaction medium of high-margin customer segments; and it is the foundation for emerging customer-focused (i.e., non-asset-based) businesses. However, this is often a new concept to companies that are transitioning out of the regulated playing field. With respect to business process automation and cost management, we believe that substituting technology for labor is far from exhausted in the energy utility sector. Indeed, utilities need only look at the petroleum industry to see what can be accomplished. Technology is important as the preferred transaction medium for certain customer segments because customers that prefer electronic communication and business transactions are typically easier to maintain, cheaper to serve, pay reliably, and use larger amounts of energy. Finally, technology is the foundation for businesses such as retail and wholesale energy marketing. Companies operating successfully in these market segments have few capital assets, experience few barriers to entry or exit, are one of many sellers, and offer a standardized product – the economic definition of a competitive market. Making Technology Decisions Technologists who have relied on traditional energy industry IT solution providers (e.g., the “Big 5” consultants, IBM, etc.), and the providers themselves, are facing difficult choices. Are traditional energy utility applications, developed in response to the regulatory paradigm, able to migrate fast enough to match evolution of the energy markets? Furthermore, can new applications touting competitive capability accommodate draconian energy market evolution through organic change, or will these products have to be completely reworked within three to five years? The answer is traditional applications are inadequate in the face of new competitive requirements, and recent implementations of new applications touting competitive capability will have to be reconfigured in the first decade of the next millennium as the true shape of the competitive energy markets becomes known. While traditional IT solution providers are quick to demonstrate success in serving other competitive markets, their experienced energy utility experts, despite a jocular view of government regulation, have lived too many years in the regulated paradigm to bring truly competitive experience to their energy clients. Technologists relying on the new breed of energy industry IT solution providers (e.g., ERP and CRM vendors, “new age” integrators) are only slightly better off, because the form and nature of the future energy markets and the business processes that will dominate these markets is uncertain. Thus, bringing pure competitive market experience to the equation is valuable, but probably not timely. The energy market in transition is a difficult master to serve from either direction – from the old regulated paradigm chasing the pace of change, or the new competitive paradigm leading it. We caution technologists not to over-invest (1999-2002) in competitive technologies (e.g., CRM, ERP, e-business) that are either ahead of the cultural and structural shift in the energy markets, or that stand the risk of not applying to the energy markets as they will be defined over the next five years. We believe available products in both spaces will proliferate (2000-2005), and existing products will become more flexible and capable of supporting rapid change and off-the-shelf customization (not an oxymoron, this implies a solution where an enterprise integration backbone will accommodate various off-the-shelf solutions, enabling users to customize their CRM “faces” to their customers, etc.). This implies a strategy of accommodating the existing application suites (including legacy applications), and awaiting both more information about the shape of future markets and the inevitable flow of quality off-the-shelf solutions aimed at that market. 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.