Internet Trading Exchanges To Drive Further Utilities Restructuring by Chris Trayhorn, Publisher of mThink Blue Book, November 15, 2000 Key Term: Portals Defined A dizzying array of terms is used to describe the various online communities available to utility companies to facilitate communication with suppliers, traders, and brokers. Ultimately, they can be boiled down to two categories: portals and exchanges. A portal is a site that can aggregate content or information based on a defined role. There are three types of portals: Web Interface Portal – Supports remote Internet access to single applications, including front-office, back-office, and relationship applications, based on a user’s role within a company Decision-Support Portal – Aggregates information from various sources within and outside of an enterprise and presents it in an organized fashion to a role-based user for analysis Destination Portal – An independent website that organizes information based on user-specified preferences Key Term: Exchanges Defined Trading exchanges, on the other hand, are online, hosted services that facilitate the flow of money, goods, services, or information. Unlike portals, exchanges support relationships between many individual companies. There are four types of exchanges, which have different business models depending on their ownership and goals (see Figure 2 in the white paper): Independent Trading Exchange (ITE) – An ITE is an independent intermediary connecting many buyers to many sellers. It operates the exchange as a profit-making enterprise, attracting liquidity by creating market and transaction efficiencies. Private Trading Exchange (PTE) – A PTE is owned and maintained by a company to more effectively manage interactions with its trading partners. The exchange is one-to-many, with the owner a participant in each deal. The owner has the opportunity to improve process efficiency, asset optimization, and collaboration within its community. A PTE also tries to take market share by focusing its trading partners’ attention away from competitors. Consortium Trading Exchange (CTE) – A CTE is formed by a consortium of major industry players, often representing a significant fraction of liquidity in the market. It operates like an ITE but doesn’t necessarily have the same profit goals, seeking primarily to reduce transaction costs and make the market more efficient for its users. CTEs are often formed in response to ITEs and PTEs. Vendor Trading Exchange (VTE) – VTEs are generally created by a large enterprise software vendor as a means to continue to grow and sell more software and services to its customers. The large installed base of the vendor is translated into users of the exchange. So far, no VTEs seem to have emerged in the energy space. Large enterprise software vendors i2 Technologies, Inc. (Irving, TX), PeopleSoft, Inc. (Pleasanton, CA), and Oracle Corporation (Redwood Shores, CA) have announced VTEs in other industries. SAP AG (Walldorf, Germany) is the most likely candidate to attempt the energy business, given its strong Utilities industry business unit. Given the lack of large vendors in this industry, we expect that the other business models will dominate. A few of the exchanges have grown out of trader desk software vendors, such as Altra Energy Technologies, Inc. (Houston, TX); however, because that software is not used enterprise-wide, we still classify them as ITEs. We expect that over time many of the software vendors will migrate their software product functionality into the exchange, becoming Application Service Providers (ASPs) The Issue: Do Utilities Need Online Trading Exchanges Now? Energy-related trading exchanges are emerging daily, presenting a bewildering array of options to each company in the value chain. However, few of them are fully operational, which only adds to the uncertainty. The Chief Information Officer (CIO) must navigate this new realm, keeping the following in mind: Should you participate in an exchange? If so, which and how many? Should you invest in an exchange? How can you tell which exchanges will be successful? Do trading exchanges create an opportunity to fully outsource some business processes? How do you manage user desktops to access and integrate with trading exchanges? Trading exchanges are poised to become a major force in your business. Companies that effectively use the exchanges have the opportunity to reduce costs and respond to the market faster. For unregulated entities, this is an opportunity to gain market share; regulated entities can reduce costs and improve margins. Conclusions: Online Trading Exchanges will Change Utility Business Relationships Figure 1 shows the pieces of a once vertically integrated utilities industry, which is now separated to foster competition under deregulation. Online trading exchanges fit neatly between the pieces to form a network that relinks the operating companies electronically. Exchanges can accomplish much to: Create an efficient market capable of handling a 10-fold to 100-fold increase in transaction volumes with the same people and more price transparency Extend the scope of each participant as the industry consolidates and becomes global, including both geographic coverage and the convergence of utility services, such as gas and electricity Become an electronic conduit to connect business processes that now require a many-to-many connection between corporate entities. This natural opportunity will be exploited: it is just not clear whom the winners and losers will be. Utility companies must get involved early in the game or their competitors will reap the rewards: Trading exchanges provide opportunities to reconnect utility business units unbundled by deregulation, expanding the connections from one-to-one to many-to-many. Value-added services are required for trading exchange success. Online trading exchanges for fuel and energy are the most established because of the history of brick-and-mortar exchanges in commodity markets. Procurement of assets/services is a major opportunity to reduce supply chain costs. Exchanges will accelerate the shift to virtual companies through the outsourcing of services. Exchange technology will create new data services companies, centralizing data-intensive tasks that would otherwise be replicated by each market participant. Energy marketers will co-brand retail trading exchanges rather than develop their own technology. Homogeneity of the industry will drive fast consolidation of competing exchanges. Figure 1 Utilities Trading Exchange Universe See larger image Recommendations Establish clear objectives for your participation in any exchange. Your participation and/or investment in an exchange should be focused on business benefits from a more efficient market, not on market power. Reduction of transaction costs for all parties is critical for success. Explore and participate in emerging exchanges while they are still in their infancy. You must learn how to use them and how to change your business processes to reap the full benefit. There is no reason to commit to only one exchange in a category until your volume increases to the point where it is your dominant style of business or the exchanges begin to consolidate. Get involved in consortia if possible. It strengthens their position and gives you an inside look at how they are developing. Be agile and ready to change your plans. View your participation in exchanges as a portfolio requiring constant attention as the market changes. Increase and decrease participation in specific exchanges as you better understand your needs and particular exchanges start winning the race for liquidity. Plan for the inevitable consolidation if you decide to launch your own private trading exchange. It will happen quickly, perhaps even before any of the exchanges is fully up and running. Look for opportunities to extend the outsourcing of services and to further restructure through the exchanges. This model is used in the telecommunications industry, and it will soon move to energy. Develop plans for integration simultaneously with your back-end systems as your participation increases and the exchanges evolve. You should plot an interception course in the future when the exchanges are mature enough and your system replacements are far enough along that the value of integration exceeds its cost. See larger image See larger image Detailed Analysis: Trading Exchanges Provide Opportunities to Reconnect Utility Business Units that were Unbundled by Deregulation More Communication is Required Under Deregulation As vertically integrated companies before deregulation, utility companies had one-to-one internal communications and business processes to connect the value chain. Then came deregulation, which is intended to create open markets at several steps in this value chain and requires the following: New company-to-company communications between the unbundled groups and new market participants, including retailers, large end-users, and new suppliers Many-to-many interactions at each step, as the local distribution company must coordinate delivery under hundreds of agreements among users and suppliers Increased total number of interactions between participants both because of the number of participants and the increase in risk management trading If you continue to use manual processes, the administrative staff needed could cost more than the savings from market efficiency under deregulation. AMR Research has surveyed the market interest in a more automated approach, and we find that Internet-based trading exchanges are arising at each of these natural markets (see Figure 1). Exchanges Focus on a Particular Business Process There are four major types of exchanges, each delivering a basic business need. The vast majority of the exchanges are sticking to one type of business thus far, but this could change as the market consolidates. (See Figure 2.) New exchanges are announced every day, often to counter a competitor’s announcement the previous day. Our experience in other markets indicates that over a relatively short time, some will fall by the wayside while others will consolidate. Figure 2 Business Models for Trading Exchanges Value-Added Services are Required for Trading Exchange Success As users of trading exchanges become more sophisticated, the simple websites of the past are no longer enough to generate fees and high valuations. AMR Research tracks hundreds of exchanges in all industries and sees the depth of services provided around the basic trading as necessary for the long-term success of an exchange. Content, Community, Commerce, and Connectivity The value of an exchange to the user depends on the services offered by the exchange. As illustrated in Figure 3, the value rises quickly with the level of services. More mature exchanges have moved up the curve through the following steps: Basic content starts a site off in the information stage. All exchanges provide this, but those that are only content providers, such as Energycentral.com, are operating on a publishing model, with subscriptions and advertising as the primary revenue. Getting site visitors to communicate with each other builds a community. The exchange doesn’t actually complete transactions, but facilitates them by bringing buyer and seller together through bulletin boards, postings, Request for Quotations (RFQs), and auctions. Some are attempting to show market pricing, such as bid and ask prices, but unless the exchange takes a role in the transaction, knowing whether and when the deal was actually consummated is difficult. The value of an exchange starts to rise quickly when it becomes a real vehicle for commerce in the market. By providing services to complete, clear, and settle the transaction, the exchange reduces the costs for all participants. In addition, the exchange can provide services related to the transaction, such as credit verification, arranging transportation, and tracking the status of the order. In some cases, the exchange may utilize existing Electronic Data Interchange (EDI) services, saving each participant from setting them up. Time saved on these tasks can now be applied to increasing the velocity of transactions with the same staff. Eventually, the exchange needs to direct connectivity to the business. This integration step can be both necessary and expensive (see The Report on E-Business Infrastructure, May 2000, “Integration – For Trading Exchange Survivors Only” for more details). The bookkeeping of the transactions automatically flows, further reducing the time and costs. More importantly, integration can extend workflow for business processes beyond a single company, tying together the sequence of events necessary for the transaction to be completed by all sides. Other trading exchanges providing services to support the transaction can also be electronically involved. Figure 3 Value of Trading Exchanges to Participants Online Trading Exchanges for Fuel and Energy are the Most Established The commodity markets for fuel and energy are ripe for Internet exchanges, as the concept of each and Over- the-Counter (OTC) trading are well established there. Figure 4 shows commodity exchanges as the most numerous and mature type. Figure 4 Types and Maturity of Selected Utility Exchanges Early Success Spawns Competitive Announcements The success of early commodity ITEs, such as Altra Energy and HoustonStreet Exchange, Inc. (Portsmouth, NH), has finally attracted the attention of the masses. Or was it Enron Corporation’s (Houston, TX) high-profile launch of the Enrononline PTE? The other large energy companies suddenly realized that these operations were building enough liquidity to threaten their position in the market. They didn’t want to pay fees to an independent or cede market share to a competitor. New Players Target More Participants or Different Commodities With much of the market still handled by phone and fax, new entrants still see an opportunity to differentiate themselves: Unlike some exchanges that only admit principals to the deal, True Quote LLC’s (Louisville, KY) exchange is also appealing to brokers. RedMeteor.com (Sugar Land, TX) plans to also trade crude oil and add analytical value to market information and news feeds. eSpeed, Inc. (New York, NY) is entering the commodities market after successfully launching a securities and financial instrument trading exchange. New York Mercantile Exchange (NYMEX – New York, NY) recently announced eNYMEX, which will leverage the NYMEX trading infrastructure. Specialty marketplaces, such as the KEFI-Exchange, Inc. (Calgary, AB), are popping up to trade emissions credits. These markets may be limited by rules, such as those New York State is considering to restrict New York utility companies from selling credits to neighboring states. Services for Completing the Deal will Separate the Winners and Losers Merely facilitating deals that must be closed offline on paper will not cut it in the future. Exchanges must reduce the cost of doing business in order to earn fees. AMR Research sees several important services that will be demanded of exchanges: They must provide settlement services and the coordination of transportation for physical commodities. These tasks take considerable time and effort for the trading companies, and there is value in automating them. They must provide integration to mid-office and back-office systems at the trading company. Trading exchanges will increase the volume of trades, but companies will not want to scale staffs proportionally. Level of Fees is Driving Consortium Trading Exchanges The largest user companies are realizing that exchanges may become a major factor, and that ITEs and PTEs are threatening to control parts of their market and extract substantial fees. Fees are a sensitive issue: no one wants to raise the cost of doing business. Some naive exchanges that started in the surplus equipment market are asking for fees that are an order of magnitude higher than typical broker fees. As one trader told us, “I’m going to do an auction on eBay to see who will give me the lowest pricing structure!” The response is to create CTEs and get in on the action. The group of six trading subsidiaries – American Electric Power (AEP), Aquila (Utilicorp), Duke Energy, El Paso Energy, Reliant Energy, and Southern Company – is an example of this trend. Motivation is a key issue for those starting exchanges. While ITEs must justify the cost of startup with returns to investors, CTEs have different needs. To companies that trade billions in commodities every month, the few million to start an exchange is less material. They benefit far more from more liquid markets and lower costs enabled by the exchange. Growth of Volume is Tied to the Emergence of the Deregulated Market The commodity markets are tied to the success of deregulation. If strong market competition emerges, companies will turn more to trading to manage their risk and make additional profits. Low-fee exchanges are a prerequisite for volume trading, but a more dynamic energy market is required. Procurement of Assets and Services is a Major Opportunity to Reduce Supply Chain Costs AMR Research estimates that utility companies spend over $40 billion on goods alone each year in the United States. While utility companies each have their own design specifications, they buy essentially the same or similar components from the same suppliers. Both buyers and sellers are consolidating, creating the potential for optimizing this enormous supply chain. Companies must make sure, however, that they look for cost reductions in the right places when joining procurement exchanges. Supply Chain Services are More Important than Unit Cost Reductions The simplistic view is that if buyers aggregate their purchases, they can squeeze the supplier for a lower price. In reality, the margins can’t support it. The automotive industry has also toned down such talk after the Federal Trade Commission took interest in the potential abuse of market power. The real opportunity is to reduce the supply chain costs of both the buyers and sellers – a win-win proposition. A trading exchange can aggregate demand, helping manufacturers plan better. It can also shorten delivery cycles and redirect product to reduce the inventory needs of both sides. Finally, it can simplify commercial interactions for purchasing and delivery, eliminating paperwork and costs. Catalog and Part Numbering will be a Major Hurdle The major hurdle to exchange efficiency is mapping utility part numbers to common industry or vendor part numbers. Even without exchanges, this process will be a major expense as utility companies merge. Each company, and even each district in a single company, may use different part numbers for the same item. Other industries, such as Electronics, have tackled this problem by using Component Supplier Management (CSM) software. There is an opportunity for the exchanges to provide this normalization as part of their value-added services, saving the utility company from the upfront cost of buying and implementing CSM applications. Managing Construction is a Sleeper Opportunity Much of the utility infrastructure is constructed and overhauled under competitive contract rather than by utility employees. A hidden cost of this work is the bidding and contract management process, which requires communicating and negotiating based on technical design documents, such as plans and specifications, and ongoing project status tracking. The General Construction industry has started turning to the Web to speed up these communications. For example, at the low end of the spectrum, sites from vendors like Buzzsaw.com, Inc. (San Francisco, CA) offer collaboration areas for posting and negotiating RFQs and working through contract issues as they arise. More substantial efforts are underway from large project management software vendors, such as Primavera Systems, Inc. (Bala Cynwyd, PA), which recently established partnerships with Bentley Systems, Inc.’s (Exton, PA) VIECON.com and PSDI’s (Bedford, MA) MRO.com, to tie together project management and purchasing. This eliminates the physical paper duplication and express delivery charges, thereby shortening the turnaround time for all involved. Consortium Trading Exchanges may Overcome Supplier Reluctance to Participate Suppliers are not anxious to give up margin or direct contact with their customers to ITEs. The ITEs are seen as an additional middleman, and both buyers and sellers are unwilling pay high (less than 1 percent) fees for the privilege of continuing longstanding business relationships. As with commodities, consortia of large buyers can create lower-fee exchanges, where the savings to each side by centralizing supply chain services make both willing to participate. The original PTEs in the automotive industry quickly became a consortium as major Original Equipment Manufacturers (OEMs) joined their exchange plans together. Exchanges will Accelerate the Shift to Virtual Companies through the Outsourcing of Services Utility companies need to look to future business models when replacing their internal systems and hooking up to exchanges. A key place to look is the use of third-party contract crews for both routine and emergency maintenance. This is already common for some procedures, such as tree work, but it could become far more prevalent as regulated local distribution companies spin out some departments to reduce costs and become more profitable. To do this, several capabilities will be required: An exchange listing for each work item, including equipment and skills required – CES International, Inc. (Minneapolis, MN) has been demonstrating the use of the Internet to trade emergency crews as part of its MyCentricity product, scheduled for release in 4th quarter 2000. A means of exchanging technical information about the assets-Ideally, all crews will be able to participate with mobile computing platforms to directly view Geographic Information System (GIS) data and report work completed. Business integration of this type has already emerged in the telecommunications industry. For example, Figure 5 shows how a virtual organization has been created to support the emerging Digital Subscriber Line (DSL) market using Vitria Technology, Inc.’s (Sunnyvale, CA) Businessware for DSL product. While the customer is on the phone with the Internet Service Provider (ISP), provisioning is arranged through electronic contact with one or more DSL providers, which must check with the local exchange (ILEC) to see what level of service can be promised. In addition, arrangements must be made for a customer premises equipment provider to deliver and install the necessary equipment. Some of these interactions may require contacting multiple competing service providers to find the best price and availability of technicians. ESP Utility.com is adopting this technology to automate connections with its partners. Figure 5 Virtual Organization for DSL Service in Telecommunications Exchange Technology will Create New Data Services Companies When utility companies were monopolies, providing all services to a customer in a geographic area, data about customers and the market could be centralized in the company’s computers. In a deregulated market, every participant needs the data on their customers. In addition, most jurisdictions have rules on sharing the data on customers that are considering changing suppliers. Core Data Services Technology Used Today for Operations and Marketing Some organization, usually the local distribution company, is currently responsible for settlement and billing. Applications from vendors such as LODESTAR Corporation (Peabody, MA) take actual usage data and conditions to profile individual loads and calculate actual energy usage for settlement. This same information is also used to provide value-added services to customers via utility or independent Websites, such as from Energy Interactive, Inc. (Oakland, CA). Centralizing Data Services Eliminates Redundant Operations and Provides Security When more than one participant needs to assemble this data and analyze it, there is an obvious duplication of effort, software, and staff. As more participants enter the market, it would be more efficient for them to acquire the processed data as a service rather than build the capability and data connections in-house. This need will only intensify as more service locations add interval metering for multiple utility services. Emerging New Organizations could Take On this Role The biggest unknown is who will end up providing these services. Potential providers include the following: Local distribution companies have made some moves here, including the recent contract announced by Logica, Inc. (Lexington, MA), which will develop a market data system for AEP in its Ohio and Virginia territories. Independent System Operators (ISOs) need the information for market settlement and would be a logical participant. Meter data management companies, such as Invensys Measurement Services (IMServ – Raleigh, NC), have been established in some jurisdictions. As markets become more competitive, the neutrality of the party providing these services will become important. An ITE is a natural location organizationally. It is also technically ideal, because all participants can access it relatively inexpensively, eliminating the need for new EDI services for the new participants. Energy Marketers will Co-Brand Retail Trading Exchanges Rather than Develop their own Technology While the retail opportunity for energy and related sales has exploded, potential Internet-based marketers, including the traditional energy companies, face an expensive technological challenge to put up a site. Early movers in this space, including Excelergy Corporation’s (Lexington, MA) E-Choicenet, energyguide.com, and Enermetrix.com (Maynard, MA), are taking a different tack, providing exchange services to the marketers. Though their functionality is quite different, each has pursued cobranding and private labeling agreements with marketers needing the functionality and content of their sites. The marketer can embed the capability in its own site and tailor the content for the desired service area. We expect this type of cobranding service to dominate the market as service providers try to move their routine contacts with customers to the Internet. Homogeneity of the Industry will Drive Fast Consolidation of Competing Exchanges The energy industry is a natural place for trading exchanges. While each utility company may have its own unique way of doing business, the technical problem of delivering energy is highly standardized. This commonality should accelerate consolidation of the dozens of trading exchanges popping up in the Energy industry. The first steps of consolidation have already begun, following a pattern AMR Research has seen in other industries, such as chemicals and automotive. This consolidation starts even before all the announced exchanges are up and running. The emergence of CTEs means everyone now recognizes that exchanges will be a force in the market. Too many exchanges run up costs, so market consolidation is inevitable. The big question is which ITEs have the financial reserves to hold out for a good deal. Consortia are Fragile and Subject to Internal and External Attack As nominal competitors, the consortia members need to figure out how to work together. Many forces will conspire to break them apart, including the following: Abuse of market power in either trading or procurement will drive away participants and attract government regulators. The Federal Trade Commission is closely watching large consortia, including the automotive trading exchange COVISINT. Excessive fees or unrealistic expectations of return from the investment in the exchange will limit growth. Consortia members may profit from future equity sales of exchange ownership, but they must keep their primary goal – cost reduction and liquidity – in mind. CTEs Need to Behave like ITEs to be Successful CTEs will be most successful if the consortia members separate their ownership interests from their trading interests. To attract traders from outside the consortia to the exchange, the operation must go to great lengths to be independent and treat all parties identically. To reap the benefits of lower costs through the exchange, their goal should be to keep costs low for everyone and attract traders. Attempts to exert control over daily trading will only help competing exchanges. CTEs and Existing ITEs will End Up Working Together The consortia have been announced, but they need to build the exchange platform to launch. AMR Research expects that most consortia will end up teaming with operating ITEs, a marriage of liquidity and technology. ITEs must evaluate these offers carefully. While such an action might seem like selling out, it may be the best way to ensure their exchange is still standing at the end of the consolidation phase of the market. The operating ITEs must be wary of well-funded new entrants, such as eSpeed and the New York Mercantile Exchange. 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.