Background

Recent dramatic changes in the electric utility industry have systematically
motivated traditionally integrated utilities to functionally or legally
unbundle their business segments. While many utilities are actively separating
their business units into a myriad of organizational structures, nearly
all utilities are separating their generation business from their wires
businesses (distribution and transmission) at a minimum. As these structural
changes occur, the formation of multi-tiered holding companies to legally
recognize operational reorganizations has become prevalent. Although most
of the reorganized entities qualify for exception from the provisions
of Public Utility Holding Company Act of 1935 (’35 Act), they have frequently
established “service” companies similar to mutual service companies as
defined in the ’35 Act. In is important to understand that the formation
of a service company is not, in any way, analogous to the adoption of
a SSO.

Unfortunately, because of the regulatory precedent including the ’35
Act, a pattern observed across most utilities is the attention focused
on the legal and regulatory aspects of the SSO. This attention is not
surprising or misplaced. Virtually every utility today must comply with
state commission regulations, as well as SEC requirements. These regulations
often require the utility to organize a separate legal entity for its
SSO and follow specific guidelines regarding pricing services and invoicing
customers.

However, utilities often neglect to address many other organizational
and management changes that are necessary to distinguish the SSO from
its predecessor entity, the corporate overhead function. As a result,
many utilities’ SSOs are not driving out costs or improving service as
expected, and many are not providing the suite of cost-effective services
that were promised to the business units.

Watershed Events

The launching (or re-launching) of a shared service function should include
five critical events, including:

Achieving organizational understanding

• Developing a new operating model

• Rationalizing the suite of services

• Improving the cost assignment methods

• Providing technology to support cost assignment and reporting

Achieving Organizational Understanding

Establishing a shared service organization should really represent a
different way of providing improved support services to the utility and
its affiliates. This message cannot be effectively conveyed with an email
message – it must be hand-delivered by the right messenger. The first
watershed event involves selecting a rising star in the utility as a sponsor,
who will be responsible for getting the organization to understand the
SSO concept and embrace this direction.

The oft-repeated admonition to select a star to champion the initiative
is particularly important because the utility is essentially launching
a private enterprise within the organization. The SSO initiative should
have a respected, visible and involved executive sponsor who has a stake
in the success of the SSO. This sponsor must devote enough time “selling”
the SSO to his or her peer group in one-on-one settings, as well as championing
the SSO to the entire utility.

Once the SSO sponsor “gets religion,” the managers of the SSO support
groups must also be “converted.” Key to this conversion process is the
recognition that the SSO exists to serve the customer and that a “provider/customer”
relationship will be established.

The second wave of understanding and buy-in must take place between the
managers of the SSO support groups and the leaders of the business units.
Although BU leaders usually do not request services directly from the
SSO, they need to understand what services are being offered and how their
business units will be charged. More important, these BU leaders must
perceive that they are receiving value from the SSO.

To accomplish this leap of faith, the newly-converted leaders of the
SSO support groups should develop the habit of meeting regularly with
the BU leaders to identify new services required, discuss progress meeting
cost and service levels, and solicit feedback on the SSO’s performance.
This type of behavior is foreign to most corporate support czars and requires
SSO managers in many utilities to develop new skills.

It is typically difficult to measure a utility’s success in getting these
types of messages across. However, an indication that the SSO message
has been understood by the organization is when BU leaders begin to look
forward to the annual planning process and the promised ability to negotiate
support service costs with the SSO.

Developing a New Operating Model

The second watershed event is the recognition that the utility is departing
from the historical corporate overhead model and adopting a new operating
model that is based on a “provider/customer” relationship. At the heart
of many of these failed attempts is the lack of a formal operating model
and a lot of misconceptions about shared services. Shared services must
be viewed as more than a centralization of business practices currently
existing in different business units.

Progressive utilities take the time to formally document the new operating
model in the form of guiding principles. These “rules of engagement” should
be developed jointly by the CEO, the SSO executive sponsor, and key stakeholders.

The guiding principles should address the following issues:

• The objectives of the SSO (i.e., reduce cost, improve service levels,
  leverage technology, standardize processes, allow the BUs to focus
  on their core business or meet regulatory requirements)

• The scope of services that the SSO will offer (e.g., human resources,
  etc.)

• The organizational units within the utility which represent the SSO’s
  customer base (the SSO’s market territory)

• The rules governing the ability (or inability) of business units
  to “shop around” for services which the SSO offers – today and long-term

• The rules governing the ability of the utility’s non-regulated subsidiaries
  to “shop around” to obtain services – today and long-term

• The accounting charge-back methods which will be used to assign costs
  to customers for services provided

• The basis for charging customers

• The SSO’s responsibility for managing the cost and quality of services
  provided

The last item in the guiding principle is perhaps the most important
one for the SSO to live with. In the SSO environment, the support group
is accountable to the customer for delivering the agreed-upon services
within cost and quality constraints. This mindset represents a radical
departure from the traditional corporate overhead mentality.

The SSO framework should also speak to an organizational issue that many
utilities fail to address, namely, an examination of where each support
process will be performed. Determining the optimum split of responsibilities
among the corporate support group, the SSO, and the BU should be addressed
by the following questions:

• Which portions of the support process should performed at the corporate
  level in order to achieve appropriate levels of oversight and governance?

• Which portions of the support process should be performed by the
  SSO in order to achieve cost savings, improve service levels, standardize
  processes, or leverage technology?

• Which portions of the support process should be performed by the
  BU for control or decision-making purposes?

The resolution of these issues depends on the organizational model that
the utility selects when the SSO is formed. One model frequently seen
includes three tiers: a small corporate support function that houses selected
strategic or governance services; the SSO that houses the transaction-oriented
services; and the BU that performs other activities. Many utilities using
this model refer to their corporate support area as the “Corporate Center”
which typically houses legal, treasury, internal audit, investor relations,
tax, strategic planning, HR policy, and supply chain policy. Figure 1
depicts this three-tier model for the procurement process.

Figure 1
Distribution of procurement activities in a three-tier model
See
larger image

Another model eliminates the corporate support function entirely and
places all support services in the SSO. In both models, certain pieces
of each support process remain the responsibility of the BU.

Utilities that have elected to locate the governance activities in their
SSOs may force more scrutiny on the cost and value of these services.
This model also implies that the SSO and the BUs will negotiate the charges
for these services. Leaving these strategic/governance services in a corporate
support group may send a “hands off” message and allow obsolete overhead
allocation methods to be continued in the future.

The typical types of responsibilities assigned to each of these areas
are:

• Corporate Support: Establish policies; provide strategic direction;
  manage risk; resolve issues; provide oversight; allocate capital;
  and monitor investments

• Shared Service Organization: Process transactions; provide
  services

• Business Unit: Operate the business; develop and implement
  strategy

Developing the new operating model requires time to negotiate these guidelines
and design new organization structures. More importantly, it requires
the utility leaders to be receptive to the theory and reality of this
new way of delivering support services. Finally, management must recognize
that regulatory structural constraints (i.e., ’35 Act) should not inhibit
the establishment of the appropriate management (as opposed to legal)
structure. The management structure does not need to mirror the legal
structure required for regulatory purposes. For instance, both the Corporate
Support and Shared Services personnel may be employed by a Mutual Service
Company, but for management purposes can be housed in different units
with different goals and leadership.

Rationalizing the Suite of Services

The third watershed event in the evolution to a SSO is the evaluation
of the existing products and services from the customer’s perspective.
This exercise recognizes the fact that in this new model, the people who
pay the invoices for services must be satisfied with the content, quality
and cost of the services they receive.

The trap that most utilities fall into when organizing a SSO is the failure
to rationalize the suite of services. The services provided by the previous
corporate support function are often just re-labeled as “shared service
offerings.” When this route is chosen, the SSO leader can’t understand
why internal customers are not thrilled with the new support organization.

The progressive SSO leader recognizes that now is the time to consider
the following opportunities:

• Eliminating services (and costs) that do not add value to the customer
  or the utility

• Adding services that the customer needs and the SSO is capable of
  delivering at the right price

• Unbundling or consolidating services so they better meet the customer’s
  needs and “buying patterns”

• Matching the quality and the level of service to the customer’s needs

• Outsourcing certain services to improve the cost and/or the quality
  of services

• Moving activities previously performed by the SSO to a BU

An objective party is helpful for this exercise because it involves meeting
with the people in the BUs who actually request and/or “consume” the SSO
services and asking some hard questions. This exercise should also involve
selected corporate oversight people to assure that regulatory, safety,
and strategic issues are addressed as each service is evaluated.

At the heart of the SSO model is the concept of standard processes. During
this examination of the SSO offerings, individual customers often demonstrate
the need for different levels of service and quality. The progressive
SSO organization should strive for a “one-size-fits-all” approach to packaging
its services to achieve standardization of processes and costs. Certain
services that are unique to certain groups (e.g., nuclear safety inspection
services) are probably best left with the BU and not relocated to the
SSO.

Up to now, the SSO journey has been relatively painless; the SSO has
been announced, the organizational design has been developed, and the
SSO has determined that the suite of services needs to be rationalized.
Following through with the rationalization of services implies that the
utility will deploy the right number of people who have the right skills
to the appropriate location in the organization (i.e., the corporate support
function, the SSO, or the BU.) Unfortunately, this is another trap that
many utilities fall into: The services are rationalized (but the work
force isn’t), and costs do not decline as anticipated or the quality of
services does not increase as promised.

The rationalization of the services should also include examining each
SSO leader as a potential marketer, because the new SSO model requires
this mindset. To mitigate the lack of marketing skills by the SSO management
team, some utilities have established internal marketing managers to solicit
business from internal customers and act as a single point of contact.

A final caution on the suite of services relates to understanding. Most
utilities overestimate the ability of the SSO employees and the BUs to
fully understand the newly published suite of services. A conscious effort
must be made to ensure that both the “seller” and the “buyer” understand
the “new and improved” suite of services, including what is included in
each service and how the customer is charged.

Improving the Cost Assignment Methods

The next watershed event that distinguishes the SSO from its predecessor
organization is improving how services are charged to customers. Most
corporate support groups have historically used one or two simple methods
to allocate the cost of services to internal customers (percentage allocation
being the most popular). The charge-back issue receives the most attention
by the customer and represents an easy way to improve the emerging “provider/customer”
relationship.

This event must take place in connection with the rationalization of
services described above. Once the proposed suite of services has been
finalized, improved types of cost assignment methods should be developed.

Experience has shown that three basic types of cost assignment and cost
allocation are typically used, including:

• Percentage allocation

• Project-based allocation

• Transaction-based allocation

For each of these methods, an inverse relationship exists between the
ease of application and the accuracy of the cost assignment. For example,
most utilities find it relatively easy to develop a percentage formula
that is based on some BU measure (e.g., revenue) and allocate certain
support costs according to these percentages. However, this method is
typically the least precise with respect to matching the costs allocated
and the benefits received.

The last method (transaction-based) is the most accurate, but it requires
the utility to measure the quantity of service used and requires the SSO
support group to develop a unit price. Most utilities develop a standard
rate at the beginning of the year for these types of charge-backs. When
standard rates are used, the SSO must determine how to handle the inevitable
residual (actual versus standard variance) from an accounting perspective.

The next task is to select the most appropriate cost assignment method
for each service. This decision should consider the following factors:

• Which BUs use the service?

• What are the cost drivers for each service?

• What information is available to support the cost assignment calculation?

Once the cost assignment method has been defined for each service, a
worthwhile exercise is to develop a pro forma cost assignment for all
BUs and all services. This exercise is labor intensive, but is a good
test of the fairness and accuracy of the proposed cost assignment model.
Most utilities skip this exercise unless the CFO mandates it.

This may be the appropriate time for the SSO to benchmark the utility’s
cost of providing services. Benchmarking is a two-edged sword: If done
properly, benchmarking takes a lot of time and effort in order to determine
the cost of comparable services. If reliable data indicate the utility’s
costs are out of line with the outside world, the progressive utility
will either bring costs in line or allow BUs to buy these services elsewhere.

Some utilities have gone as far as funding a SSO benchmarking activity
to formalize this effort. Experience has shown that the relationship between
the SSO and its customers improves when the customers know that the SSO
is making a good faith effort at benchmarking and using the results.

The last task in the cost assignment arena is the development of Service
Level Agreements. Most utilities limit this exercise to transaction-based
services. Progressive utilities tailor service level agreements for each
category of service (percentage allocation, project and transaction-based)
and require the SSO to negotiate all of these charge-backs with their
customers.

Many utilities fail to significantly improve the fairness and accuracy
of cost assignments because insufficient resources are assigned to this
task. The development of “new and improved” cost assignment methods should
involve the finance and accounting, information technology, selected internal
customers, as well as the support group itself. This exercise must be
performed concurrently with the evaluation of enabling technology. Many
utilities have designed elaborate charge-back methodologies only to discover
that their enterprise systems cannot handle the newly designed cost assignment
methods.

Providing Technology to Support Cost Assignment and Reporting

The next watershed event is typically the most complex and the most costly.
Few of the benefits associated with charging services on a more equitable
and accurate basis will be realized if the utility’s information systems
cannot handle these new requirements. A desired outcome of the SSO initiative
should be to improve the visibility of support charges to the BU. If the
timing of the SSO initiative is not aligned with the timing of the configuration
of the enterprise system, problems usually result.

Handling the new ways of assigning costs for services used is the first
issue. These calculations are usually handled by the financial and/or
project modules in enterprise accounting systems. Virtually every enterprise
system can handle percentage allocations, transaction-based cost assignments,
and transfer of project-based costs. However, almost every system must
be configured to handle transaction-based cost assignments and project-based
cost assignments in the precise manner that has been designed for the
SSO. Hence, configuration options are usually required to handle these
calculations in the right manner.

Reporting cost assignments at detailed and summary levels to internal
customers often presents another dilemma. The reporting requirements for
the SSO environment are typically different than the standard report formats
provided by most enterprise systems.

The next potential snag is time reporting. In order to support the build-up
of costs for project-based services, SSO employees providing these services
will need to maintain time records. This timekeeping requirement has both
policy and technology implications. Many utilities do not require corporate
support employees to maintain time records. Moreover, the timekeeping
systems in place for field maintenance personnel usually do not have the
flexibility to track time by customer, project, and service. In the ideal
world, timekeeping requirements should be jointly developed by the SSO,
the human resources function, and the information technology function
to assure that a realistic framework is being designed and can be deployed.

Many utilities have launched their SSO initiatives despite the obvious
gap between the SSO system requirements and current system functionality.
Here is the resulting scenario at the end of each month: SSO support staff
or accounting personnel are relegated to handling the cost assignments
and generating reports off-line using Excel spreadsheets and other point
solutions. This effort usually generates another report that differs from
the information that the BU received from the enterprise system. The existence
of multiple reports with different cost information gives rise to the
refrain frequently used by many utility BU managers: “Those aren’t my
numbers.” The resulting chaos may have increased the visibility of the
SSO charges, but the level of understanding has taken a step backward.

A final word of caution regarding information systems deals with the
utility’s budgeting system and its planning process. A good rule of thumb
is “We budget the way we report actual costs.” Hence, the budgeting process
should incorporate the “new and improved” cost assignment methods. Many
utilities fail to recognize the effort associated with reconfiguring the
budgeting tool when they launch their SSO and resort to handling the budgeted
cost assignments off-line.

Information systems represent a potential showstopper for the SSO. Unless
the utility is prepared to make the investment to support new cost assignment
and reporting requirements, the organization will be disappointed with
the results and the image of the SSO will suffer.

Summary

Shared Service Organizations provide utilities significant opportunities
to reduce cost and allow business units to focus on their core business
practices. These opportunities have eluded many utilities because their
approach has been limited to setting up the legal framework and selecting
a new name for the shared service function. Getting the return on the
shared service function requires focusing on organizational buy-in, the
suite of services, cost assignment methods, and information systems.