Plugging in the Consumer by Chris Trayhorn, Publisher of mThink Blue Book, January 1, 2008 Thanks to new technologies and the spirit of independence and empowerment fostered by the digital age, consumers are taking on broader and more active roles in an increasing number of industries. Not only are consumers increasingly vocal and decisive about what they will or will not buy, they are in many cases becoming designers, producers, marketers and distributors of the products they once simply purchased. As an example, consider the evolution of television and other video-based entertainment. Consumers in the early television era were passive participants, watching whatever programs the networks were broadcasting on one of the few available channels at any given time. Decisions regarding content sat firmly in the hands of broadcasters. But in recent decades the media and entertainment business has changed dramatically. Cable and satellite made early inroads by providing viewers with hundreds of additional channel choices and niche programming. More recently, options such as digital video recorders, video on demand, video programming on mobile devices and online content libraries have emerged, giving consumers much greater control over what, where and when they watch. Moreover, pockets of media enthusiasts are taking on even more participatory roles, producing and marketing their own content. Could something similar happen in the energy industry? One way to look at this question is to consider parallels between the way that media and entertainment have developed, and some of the realistic future business models for the energy industry. While the two industries are very different, there’s a strong possibility that consumer involvement in the energy business could evolve along similar lines, as illustrated in Figure 1. Consumers have become more and more accustomed to choice, selectivity and multiple pricing schemes in services used every day. High tech products like mobile phones and Internet service usually spring to mind first, but personalization of services and products is occurring even in centuries-old institutions like medicine, education and food distribution. Fifty years ago, who would have envisioned customers accepting limitations on what doctors they could see in exchange for lower health care costs, pursuing degrees without attending classes or paying a premium for foods that met specific conditions on their production? Yet today health maintenance and preferred provider organizations, online degrees and organic foods are all commonplace concepts. The more consumers enjoy the benefits of options and active decision making, the stronger the pressure will be on the energy industry to adapt. This means that utilities must revisit long-held beliefs about how best to serve customers and prepare to make fundamental changes in their strategies and operations in order to prosper in a more participatory market. CONSUMER INVOLVEMENT Many utility executives are skeptical about whether consumers really want to have different energy service options, and whether they will act on those desires. After all, electricity, natural gas and heating oil are essentially commodities. But so is broccoli, and millions of consumers are unwilling to settle for conventionally grown produce. Instead, they’re willing to pay more for food certified as grown without pesticides and artificial fertilizers, and under conditions that emphasize the use of renewable resources and the conservation of soil and water.  Given this perspective, can the energy industry afford not to prepare for rising consumer demand for multiple service programs and different pricing tiers? To help address some of these questions, IBM conducted a survey of 1,900 energy consumers from six countries in North America, Western Europe and parts of the Asia-Pacific region. The survey focused on consumers’ current views and, perhaps more importantly, their expectations of the utilities that serve them. Their responses underscore four trends in energy consumer behavior, each indicating that customers value the same type of control they exercise in other parts of their lives: consumers are leveraging provider choice options, managing usage more actively, moving toward self-generation of power and making their opinions heard through multiple channels (not just public regulators). Controlling Their Purchases In some regions with competitive markets, consumers are already exercising their right to select energy providers. In the United Kingdom’s market of 48 million electricity consumers, for instance, more than 15 percent are switching per year. In addition, the IBM survey demonstrates that a basic lack of awareness may still be holding consumers back. Across the worldwide respondent sample, one out of every five consumers did not know whether they could choose an alternative electricity provider. Nevertheless, consumers were clear about wanting a choice. Among those who could not change providers or were not aware of their ability to choose, 84 percent wanted the option, as shown in Figure 2. While price will always be a factor in consumer behavior, competition is also fostering a host of decision-making criteria that consumers might not have even considered before. According to the results of the IBM survey, consumers now consider a utility’s ethical reputation, alignment with community values and environmental actions as important as traditional “buyer values” like customer service and reliability. Many consumers now have more choices about the type of energy they buy as well. More than 60 percent of the respondents to the IBM survey said they would be willing to pay a premium for green energy, and a significant minority (one in five consumers) indicated a willingness to pay at least 20 percent more for an environmentally friendly product. Controlling the Switch Only 30 percent of the consumers IBM surveyed expected their electricity use to increase over the next five years – yet 60 percent expected higher electricity bills. In times of rising energy costs, there is high motivation for conservation. But with many consumers also assuming a share of the responsibility for protecting the environment, finding new ways to better manage consumption has become a top-of-mind issue. Although consumers have always been able to reduce usage through “brute force” measures – adjusting thermostats, switching off lights and the like – they are just now gaining the ability to truly manage consumption through greater awareness and better tools. As smart meter deployment allows more consumers to obtain real-time usage data at the device and appliance level, households and small businesses will know which conservation actions really make an impact. This will enable better decisions and more permanent behavior changes. Controlling Supply When providers are unwilling or unable to satisfy their needs, consumers have an increasingly viable alternative: the technology to generate their own electricity. As consumers weigh the self-generation option, cost is clearly a significant driver but not the only one, as illustrated in Figure 3. If self-generation could reduce energy costs by 50 percent, well over half of the consumers we surveyed would be motivated to install, maintain and operate their own power generation systems. Yet among those same respondents, reliability and environmental impact seemed to matter more than a small (10 percent) cost reduction. Interestingly, getting paid for surplus power received the most favorable reaction from survey respondents. Besides offering a financial payback that helps offset upfront investment and operational expense, we suspect this response also reflects an underlying desire to assert more control over a purchase for which conditions have historically been dictated to them. Many of the industry executives we interviewed agree that widespread adoption of self-generation is not that far off. More than half believe that the value from a low-cost, low-emission generating technology could move a significant percentage of residential and small commercial customers to self-generation within the next decade. It’s important to note that although the “competition” for traditional utility companies has traditionally been viewed as emerging alternative providers employing the existing distribution system, focusing only on this particular threat results in an incomplete picture. If technologies such as small-scale solar and combined heat and power generation were to rapidly drop in cost, customer migration to these options would serve as another competitive pressure for which utility executives would have to develop a defensive strategy. Controlling Their Own Destinies It’s easy to understand why consumers might become skeptical about the utility industry given power blackouts that affect millions of people, price hikes driven by factors that are little understood and the pursuit of mergers and acquisitions without benefits that are clear to customers. Events like these contribute to growing consumer concern – not only about utilities and their motives, but also about the regulatory process currently in place to protect the public. Consumers are increasingly unwilling to wait for regulators to act “in their best interests.” Instead, they’re going directly to lawmakers, the press and special-interest groups to try and enforce change. For example, in January 2007, a 1997 Illinois deregulation bill expired, ending a 10-year rate freeze. As the shock of a sudden and dramatic rate increase set in, public pressure caused legislators to intervene – ultimately driving the state’s primary distribution utilities to provide a multi-year, billion-dollar rate relief package to help reduce the financial burden on ratepayers.  Other Drivers and Enablers of Customers’ Desire for Control Climate change is the one driver for which the goals and needs of both utilities and consumers converge. Consumers are clearly interested in the environmental practices of the companies with which they do business. Indeed, 70 percent of those surveyed reported that environmental considerations were already an important factor in choosing products other than energy, and that these concerns would ultimately also influence the energy products they purchased as well. Of consumers who are aware of renewable power options available to them, almost 40 percent purchased some or all of their power under such a plan. Among the rest, more than 60 percent expressed interest in doing so. Utilities, for their part, are making major investments and operational changes to respond to climate change concerns and policies. In fact, the percentage of utilities spending at least 10 percent of their capital expenditures on environmental compliance over the next five years is expected to double. To make the improvements needed to address the concerns discussed above, utilities will likely receive strong support for deployment of advanced energy technologies. Many of these have been available in some form for years, but their business cases have been rather lackluster. However, during the last three to five years, the technologies have continued to advance; their benefits have strengthened dramatically; and the costs of deployment have decreased. In the near term, smart meters, network automation and analytics, and distributed generation will likely drive the most industry change. The emergence of these two trends, combined with growing consumer involvement, will have far-reaching consequences for the utility industry. Collectively, these drivers are overturning traditional assumptions about energy consumers and the fundamental value proposition of the industry itself. Companies will be forced to look at their residential and small commercial customer population in discrete segments, instead of as a largely uniform block of ratepayers. Ultimately, as the degree of control shifts from the utility to consumers, network and generation technologies will move away from the traditional centralized, one-way model to a more dynamic and distributed one. New industry structures will emerge, creating new opportunities and challenging existing models. CONSUMERS: NO LONGER JUST PASSIVE RATEPAYERS Our detailed analysis of the consumer survey responses showed that two primary characteristics define different types of consumer behavior. First, personal initiative, or the willingness to make decisions and take action based on specific goals – such as cost control, reliability, convenience and climate change impacts – will drive consumer behavior. Second, disposable income – or the financial wherewithal to support energy-related goals in early adoption phases – will have a substantial impact on consumer actions, since only those with sufficient resources will be able to implement new technologies and buy more expensive products. Different combinations of these two characteristics lead to four distinct consumer profiles, as shown in Figure 4. Each consumer segment has specific needs and wants, and utilities will need to adopt different strategies, and likely develop different offerings, for each. However, before utilities can begin tailoring their approaches to particular segments, most will need to invest in tools and capabilities that help them collect and analyze consumer data, particularly as huge quantities of real-time data and new information streams are generated by deployment of advanced sensing, metering and communications technologies. THE IMPACT OF INCREASED CONSUMERS CONTROL Recent trials have demonstrated that both customers and local utilities derive benefits from consumers taking a more active role in their energy decisions. For example, in a yearlong program in the Pacific Northwest giving consumers the ability to customize their energy use to save money or maximize comfort, participants saved approximately 10 percent on their electricity bills and reduced peak power use by 15 percent. Throughout the region, the information, communications and control technologies and algorithms provided by Pacific Northwest National Laboratory, IBM and Invensys Controls helped consumers in the study become an integral part of power grid operations on a daily basis – especially in times of extreme stress on the electrical distribution system. A combination of demand response and distributed generation reduced peak distribution loads by as much as 50 percent. (For more information about this program, see “Case Study: The GridWise Olympic Peninsula Project” elsewhere in this book.) Another pilot, run by Canada’s Ontario Energy Board tested consumers’ inclination to shift and reduce demand when provided with smart meters and time-of-use pricing. On average, three-quarters of the participants shifted enough of their consumption away from peak times to save 3 percent per month on their energy bills. During four peak summer events, when penalties and rebates applied, shifts in consumption led to even greater savings – as much as 25 percent, depending on the specific plan the customer was using. As a result of their awareness of energy usage and behavioral changes, participants also reduced total consumption. This “conservation effect” amounted to a 6 percent reduction in overall usage. When combined with the effects of shifting, this allowed 90 percent of the participants to pay less than they would have paid on their prior plans – results that are particularly remarkable given that consumers were relying on monthly usage statements; if consumers had a near real-time view of their energy usage, these reductions might have been even more dramatic. (For more on this trial, see “Case Study: Smarter Prices for Smarter Consumers in Ontario” elsewhere in this book.) INDUSTRY MODELS: TOWARD A PARTICIPATORY NETWORK We believe that studies like those outlined above demonstrate the strong benefits of both technology evolution and shifts in the balance of control between utilities and consumers. The nature of the benefits will depend on the path chosen to move from current “passive” business models to more active ones. Specific types of technology and customer behavior evolution will give rise to four industry models, as shown in Figure 5. Although each model is distinct and requires different capabilities, the industry as a whole – at least in the near term – will represent an amalgam of all four models. In fact, many utilities will find themselves operating in more than one model, particularly if a company operates in different geographies. In addition, moves across boundaries will tend to be evolutionary and depend on local conditions. Where consumers aren’t as eager to assume control of decision-making – or regulators don’t allow them the freedom to do so – companies will be most likely move from traditional models through a state of operations transformation before fully enabling participatory networks. Where this path dominates, utilities will need to build business cases around cost savings and environmental benefits to deploy new technologies. In a high-cost, carbon-constrained environment, however, this should be an easier sell to regulators and investors than in the past. In markets where consumer demand for control grows faster than new technologies can be deployed, particularly in heavily regulated rate-of-return environments, constrained choice will dominate in the near term. Utilities will be pressured to meet demand for control in creative – and sometimes untested – ways. And regulators may need to be more flexible in viewing these investments than they might be with traditional utility capital investments. For both parties, early assessment of needs and review of available options will be critical. Whichever path is adopted, we anticipate a steady progression toward a participatory network – a technology ecosystem comprising a wide variety of intelligent network-connected devices, distributed generation and consumer energy management tools. Although the precise time frame for reaching this end-state is unknown, our research suggests a few major milestones. Within five years, the percentage of the world’s electric utilities generating at least 10 percent of their power from renewable sources should double. In that same time frame, we believe that sufficient supplier choice will allow meaningful consumer switching to emerge in most major competitive markets. Also, based on both consumer and utility responses, we expect utility demand management initiatives to expand dramatically and electric power generation by consumers to increase dramatically within a decade. IMPLICATIONS: CUSTOMER FOCUS AS A COMPETITIVE ADVANTAGE By leveraging the new technology ecosystem, utilities will be able to meet key objectives in coming years. Specifically, they’ll be able to: Prepare for an environment in which customers are more active participants; Capitalize on new sources of real-time consumer and operational information, and decide which role(s) to play in the industry’s evolving value chain; and Better understand and serve an increasingly heterogeneous customer base. The utility industry is fast approaching a tipping point beyond which consumers can (and increasingly will) demand equal footing with their providers. Those utilities that are prepared to share responsibility with their residential and small commercial customers, and help them meet their specific energy goals, can expect to enjoy significant competitive advantage. Filed under: White Papers Tagged under: Climate Change, Customer Empowerment, John Juliano, Michael Valocchi, Pricing, Renewables, Smart Grid, Utilities, White Papers 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.