Portfolio Approach to Cutting Costs by Chris Trayhorn, Publisher of mThink Blue Book, April 1, 2003 The renewed and particularly intense focus on performance improvement and cost reduction in utilities is traceable to three compelling drivers of change: • Strong capital market demands • Selective opportunities for growth • Increasing performance expectations for regulated business As Wall Street increases its scrutiny on energy, and utility companies become more reliant on raising capital from the financial markets, short- and medium-term financial performance and shareholder value become all-important. The fall of the trading market and continued uncertainty in the marketplace have exacerbated utilities’ deteriorating financial conditions and have precipitated creditworthiness challenges throughout the industry. The capital markets will continue to dissect the industry and its players, demanding strong balance sheet management and consistent, stable earnings. Top players are looking for ways to achieve scale economies, both through best-in-class operations and supplier consolidation. They are also motivated by a strong desire for earnings growth — internally, through cost management, as well as externally, through acquisition. Put simply, utilities are looking for sensible ways to grow and leverage their businesses, consistent with their overall business strategies. The trend toward outsourcing — from tree trimming to plant construction, from HR to finance — provides several avenues for utility performance improvement, improved resource utilization, and cost reduction. New enabling technologies, such as customer information systems and risk-management systems, will assist in enhancing performance in new businesses, enabling the utility to keep a close eye on and drive efficiencies from the core business. Taken together, the three drivers of change are generating substantial momentum for performance improvement and cost reduction in utilities. The Portfolio Approach There are many approaches to improving the bottom line. The truth of the matter is that the approach that works for one company may not get the best results for another. Why? Because each company has a different strategy, operations, health, and culture that can drive the decision variables regarding which approach to use. This article will focus on where to look for cost reduction opportunities and the various approaches that have been successful across industries. We have observed that companies often draw from a mix of approaches to develop the programs to realize their goals, driven by an overall business strategy. The mix of approaches helps develop a portfolio of projects from both a top-down and bottom-up approach. Before we focus on specific approaches, let us take a quick look at some of the opportunity levers companies use to drive cost-performance improvement. These are the areas that typically yield potential large opportunities. Benchmarking and diagnostics can be used to identify priority areas for your company. Shared Services or Outsourcing Each company has core competencies it must do well to be successful in delivering its products or services to its customers. Non-core areas present opportunities to consider shared services, or outsourcing, where the transaction-related activities of the function are the core competency of a new unit or vendor. Areas to consider include: customer relationship management, finance, human resources, information technology (infrastructure, network and applications maintenance), procurement, and facilities management. Each should be evaluated from both a business case perspective and from a strategic perspective to determine what makes sense for your organization. Organization It is obvious that the success of an organization to a large part comes from its people. Organizing effectively, with the right skills and tools combined with a sound business model and processes to deliver the strategy, is important. Many organizations are hampered by a “silo” or “stovepipe” organizational structure, where processes are suboptimal within the silo. It is critical to: look at processes from a customer point of view, migrating to best practices in procedures and technology; and effectively organize around processes with the right customer-driven performance measures and job functions to get the organization aligned and moving in the right direction. The costs should come down, and revenues and service levels should improve. Capital and Expenses Don’t forget the balance sheet and how you spend money. On the balance sheet side, receivables, payables, inventories, and assets are a source of cash that is often overlooked. Targeted programs for eliminating revenue leakage, paying per contract terms, reducing inventories through better supply chain management, and eliminating unneeded assets can improve your working capital situation and cash flow. Expenses can be attacked by evaluating expense policies and complying with them. Better procurement processes and contracts can lead to significant benefits by curtailing unneeded spending or improving unit costs through strategic sourcing initiatives. Often, recent mergers and acquisitions create many of these issues, where companies fall short on integrating best practices between the two legacy organizations. Operations Operational priorities and a tight rein on cost control govern many of the current and priority initiatives within utilities. This requires a thorough examination of strategies, skill sets, and processes. Value chain analysis also becomes critical as companies prioritize areas ripe for improvement and enhanced efficiencies. The final step consists of building the necessary process and technology infrastructure. Establishing a standard architecture for operational processes, information technologies, and management competencies optimizes a company’s ability to succeed in driving meaningful, enduring improvements to operations. The utility industry today is focused on driving cash flow, balance sheet strength, and return on invested capital through balanced, integrated operations between the regulated and merchant businesses. On the regulated side, utilities are seeking ways to enhance earnings stability and growth. Low-cost operations and regulatory innovation are key to creating premier regulated franchises. Operational excellence, best-in-class transmission and distribution (T&D) cost position, and solid regulatory relationships remain critical success factors. More than ever, our clients are renewing their focus on extracting optimum value from regulated operations. New and improved processes are being implemented to maintain and improve system reliability and customer satisfaction, and organizational structures are being transformed to meet emerging requirements of the T&D businesses from state and FERC regulators. Further efficiencies are being sought from back-office operations such as HR and finance. For merchant businesses, low-cost generation, enhanced market share at acceptable levels of risk, and aggressive risk management remain key to developing and sustaining best-in-class merchant capabilities. Leading utilities are implementing unique work management processes and solutions to enhance efficiencies within their generation businesses. Processes are being redesigned within the generation and trading businesses to mitigate risk to the organization and decrease potential adverse impact on earnings. Improvement Approaches Now that we’ve covered some areas to examine, how should we go about defining the specific programs to improve cost performance? We have chosen to focus on three approaches that have yielded results across various industries: • Budget cuts • Business process redesign • Six Sigma Old Reliable — Budget Cuts This is a top-down approach where you know there is fat to be trimmed and you need a forcing function to do it. Rather than across-the-board cuts, most companies today conduct benchmarking studies to identify target spending or staffing levels for various functions and then “bake” them into the budgets. Then, you leave it up to the organizations responsible to figure out how to get there. The advantage is it is relatively easy to set the new spending levels, but they are often arrived at through negotiation. Without an underlying structured method, it can get the desired results, but it may suboptimize operations since it usually takes a functional view rather than a process view. Also, there is often little consideration for the customer. Process Re-engineering Many companies use this method, first made popular in the early 1990s, because it focuses on how a company conducts business to deliver products and services. Makes sense. It is important to start with the business model and how the processes support the business model. Since this method is not bound by organization, it focuses on tangible improvement and reduced waste in business processes through process changes, elimination of steps, or improved technology and organizational alignment. With the development of industry-tailored software packages with industry best practice processes already included, there is an emerging trend to re-engineer to the plain vanilla, industry-standard software solutions that can reduce ongoing system maintenance and upgrade costs. The key is to customize industry-standard solutions only where you need to for competitive reasons. It is important to verify that re-engineering teams have a solid outside perspective so that they can consider breakthrough improvements and determine that the teams focus on implementation and process measures to drive the changes into the organization. Six Sigma Six Sigma has emerged since the mid-1990s, most notably through the visibility it has been given by companies such as General Electric and Motorola. It is a highly structured, process-based approach that is culturally driven using statistical tools to evaluate process performance. In this approach, certified Six Sigma black belts address specific improvement projects from start to finish. It involves a heavy investment in training and usually does not pay back for two or more years. However, Six Sigma tends to generate a lot of organizational buy-in and develops strong process-based and problem-solving skills in the organization. Successful performance improvement is dependent on developing the right projects and effectively implementing them. We suggest that you look across your organization through process-driven approaches, and you should expect to develop a portfolio of projects. Which Is Best? The approach you choose will depend on your specific situation, where you are in terms of improving your performance, the speed of implementation needed, and your desire to engage in a top-down or bottom-up approach. Our experience is that you will likely need more than one approach to achieve your desired results. Regardless of the path you take, make sure you engage the organization, create strong accountability, and measure your progress. 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.