Innovation Does Matter by Chris Trayhorn, Publisher of mThink Blue Book, May 15, 2006 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 industrys 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. Shells 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. Californias 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 industrys 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. 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.