Deregulation … mergers … spin-offs … The changes taking place in the energy
industry, including the reality that competition will increase to levels never
seen before, has prompted utilities to step up the search for cost reduction
while improving “operational excellence.” Though managing the supply chain traditionally
has been relegated to a secondary support function, many energy companies are
now trying to drive down costs and improve service levels through supply chain
excellence and through collaboration with suppliers and customers.

Why this sudden focus on supply chain? For the typical energy company, fuel
and non-fuel purchasing costs, along with internal supply chain costs, typically
account for more than a half of controllable costs — fertile ground for
cost reduction. And as the survivors gobble up weaker companies, the name of
the game becomes reducing cents per kilowatt hour to the ultimate customer.

Although many companies have embarked on the supply chain journey, the number
of false starts eclipses the number of success stories. Solutions are designed
before the problem is understood. Problems with intra-organizational cooperation,
strategic suppliers slow to get onboard, miss-starts with e-markets/exchanges,
millions of dollars spent on systems without improving management information,
strategic sourcing focused on lowest price rather than total cost to procure/own,
are among the most common sub-optimal outcomes. How can your organization avoid
the pitfalls and implement a program for sustained supply chain improvement
and have business unit leaders asking for more? For some organizations it may
be a long and challenging journey, but it begins with a single step.

Definitions

In the manufacturing sector, the supply chain is generally understood among
the manufacturers, its suppliers, and its solutions providers. However, supply
chain in the energy industry means different things to different people, with
lines being drawn more by tradition than by broadly accepted standards.

For the purposes of this discussion, we define the supply chain function as
the combination of people, processes, and technologies that complete the specification,
acquisition, distribution, and disposition of “direct” goods and “indirect”
goods.

Direct goods are primarily capital assets and the items/services used to maintain,
repair, or overhaul those assets. They may be highly engineered items, such
as power systems and transformers, or “lower-tech” items, such as utility poles.
Direct goods tend to be high-cost items and their availability has an enormous
impact on supply chain reliability and efficiency.

Indirect goods include office equipment, computers, etc. that support the overall
operation of the business, but are not directly tied to making the “product.”
Although availability of indirect goods is important, driving down the purchase
price and managing maverick buying are the primary focus as indirect goods have
a limited impact on supply chain effectiveness.

Work management is to the utilities industry what material requirements planning
is to the manufacturing industry. It is the primary “demand source” for direct
goods, and the level of integration and efficiency of a utility’s work management
function is a key factor to the overall success of supply chain improvement
initiatives.

The value chain is the extension of the internal supply chain outside of the
organization and into suppliers and customers. An integrated, end-to-end value
chain links the key supply chain processes between the organizations to drive
out additional costs and inefficiencies through collaboration, or collaborative
resource planning.

Current Forecast — The Perfect Storm

So why do most of even the most well-run utilities have significant opportunities
to improve efficiency and drive out costs of its supply chain operations? Several
factors have conspired to create a bigger “storm” than any one factor could
have on its own. There is a long list of factors, but four key factors are:

Divergent Approaches Without Standards

Energy companies have prided themselves on establishing top-notch engineering
organizations that are responsible for designing the best possible infrastructure
components. Over the years, engineers took into account regulatory, geographic,
and other factors as they designed leading-edge infrastructure components. In
the process, adjacent energy companies whose fundamental needs were similar
established standards for their own organizations, which varied enough that
even common infrastructure components were unique. As energy companies consolidate
through mergers and acquisitions, the combined organizations may have several
variants for what is fundamentally the same item. At the same time, regulatory
changes and technological innovation have reduced substantially the need for
variation, though few organizations have capitalized on these changes. Consequently,
opportunities for inventory sharing and for supplier efficiencies through standardization
have been marginal.

Dysfunctional/Disconnected Supply Chains

The creation of large energy companies, operating on a regional, national,
and even global scale, have created organizations and processes that are every
bit as complex as their counterparts in the consumer and industrial products
sectors. Over the past decade this sector invested billions of dollars to integrate
supply chain processes and to enable these processes with information technology
solutions, while most energy companies have focused on improving segments of
the supply chain without an emphasis on achieving end-to-end integration synergies.
The major enterprise resource planning (ERP) vendors raced to provide industry-specific
solutions for manufacturing firms, but few have provided utility-industry-specific
applications.

Organizational challenges have also hampered efforts to integrate supply chains.
For example, engineering, work management, and inventory management are almost
always the purview of operating companies or the individual business units,
while sourcing, procurement, logistics and others segments of the supply chain
are embedded in other parts of the operating company or in what is effectively
a shared-services organization. The lack of collaboration between the engineers,
the builders, the maintainers, the acquirers, and the movers, has resulted in
numerous inefficiencies and concomitant added costs.

Figure 1 – Energy Company Supply Chain Model

Although the emergence of electronic marketplaces or exchanges promised to
drive out many of these inefficiencies, the reality is that organizations must
be reasonably well-integrated before e-markets/ exchanges are even relevant
to integrating the internal supply chain with the inter-organizational value
chain.

Not only are there disconnects between the various participants of the supply
chain processes, there are variations in how to deal with the same supply chain
segment within the same organization. Many energy companies have several item
masters and inventory systems dedicated to legacy operations. Work management
practices vary from business unit to business unit and the majority of work
management systems are in place with little or no “enterprise view” of physical
materials inventory or human resources.

Lack of Motivation

Opponents of cost cutting argue that if you are successful in driving out cost,
you may force a rate case. Optimizing tax positions by changing procurement
and inventory management practices are two of the best ways because they may
only require policy, coding, and process changes to yield significant savings.
But some organizations are concerned that all of the spoils will simply be absorbed
by lower rates and lower budgets. In reality, many of the cost reductions could
be allocated to other initiatives that would improve the overall supply chain
processes while some of the reduced costs could be “given back,” this then enhances
the organization’s competitive position as a high-quality, low-cost provider
— a win-win scenario for the company and the customer.

Procurement and Inventory Management Practices with Limited Focus

Procurement operations within most energy companies have operated in a vacuum,
largely independent of engineering on the front end, and work management on
the front and back end. As a consequence, procurement professionals generally
set out to ensure that they did the best they could in the context of a largely
parochial view of how procurement should work. Beyond negotiating prices and
terms based on competitive bid scenarios, few procurement operations have elevated
their operations into truly strategic functions that regularly collaborate with
engineering, work management and operations, strategic suppliers, and customers
to optimize the supply/value chain process.

To improve their leverage in sourcing efforts, many procurement operations are
beginning to put into place process changes and technology enhancements that
will give them a better understanding of aggregated past spending. However,
few procurement operations have made measurable progress in aggregating demand
data, which is a critical factor in maximizing an organization’s leverage in
strategic sourcing activities. Collecting spend data is largely an administrative
or technical process focused on gathering information from a multitude of sources,
mostly automated. However, demand data may or may not be available in automated
form or in “systems” that are easily identifiable or accessible.

Items that may lend themselves to just-in-time acquisition and replenishment
are more often than not purchased and brought into inventory “just in case.”
Procurement personnel are often given the administrative burden of aggregating
demand manually or by accessing multiple systems, which takes time away from
their more critical strategic functions. Based on discussions with a number
of procurement professionals in the utilities industry, the concept of procurement
professionals acting as facilitators between engineering, suppliers, and operations
is a goal that most have but few have achieved.

Navigating to Safe Harbor

My position is in agreement with most participants working in the supply chain
of a major energy company. The “squalls” of increased competition and the issues
discussed here have combined to create a complex problem that will materially
impact an organization’s ability to compete if left unchanged. The solution
will require unparalleled levels of collaboration and openness to new ways of
thinking.

Get Top-Level Commitment First

Although most energy companies can achieve significant benefits, organizations
need to be realistic about what level of collaboration they can expect from
the supply-chain stakeholders. If there is a genuine openness on the part of
senior-level management, the first step is to agree on the rules of engagement,
or guiding principles, that will drive an enterprise approach to supply-chain
integration.

Facilitated workshops and other consensus-building techniques are powerful tools,
if the stakeholders can be relied on to engage in the process with an open mind.
These are not “pep rallies” intended to build excitement; they are focused sessions
intended to sell to highest levels of the operation the need for change and
to enlist their support in navigating through the myriad trade-offs that are
essential to world-class collaboration.

Engage Future “Owners”

Although you should start with the executive consensus, you must move quickly
to engage the people who will make or break the execution — mid-level managers,
who own the day-to-day operations. Building on the baseline established by executive
management, the focus should be on translating vision, guiding principles, and
key “get rights” into actions that will drive out inefficiencies and enhance
performance — specific actions that will be measured and ideally built
into the performance plans of those responsible for execution.

Recognize Trade-Offs, Be Realistic, and Manage Distractions

The most common pitfall that supply chain optimization efforts encounter is
setting a trajectory that is unrealistic. In securing executive-level commitment,
the end-state vision is often misinterpreted as “Release 1.” From the start,
a process that sequences initiatives in a rational, benefits-driven order is
critical to managing expectations and ensuring that the effort does not implode
once the totality of the effort is understood. Understanding the “earned value”
of discrete investments and then prioritizing based on earned value is a key
factor in managing expectations.

Resist the temptation of e-market and software providers who have the “secret
sauce” that gets you there without incrementally establishing solid internal
operations and intra-organizational collaboration. To be sure, there are opportunities
to maximize benefits through e-markets and software solutions that go beyond
the core processes, and attention must be dedicated to identifying additional
short-term benefits. However, these decisions need to be driven by a measurable
earned value, and efforts to consider added capabilities should not unduly distract
from the primary objective of integrating the supply chain.

Identify Opportunities for Leverage

Even with these problems, most organizations have made progress and have many
components of the “end-state” in place. The key is to identify these best practices
early and to showcase them. Most organizations will have process or technology
practices that can be leveraged to the enterprise. This can substantially decrease
the cost and the complexity of subsequent implementation and change management
efforts.

If a best practice happens to come from the parent company or one of the larger
business units, the value must be sold to the smaller business units to avoid
the perceptions that the “collaboration effort” is little more than an attempt
to force an unsuitable solution upon the smaller operations. The smaller business
units may also view some of the capabilities as “a hundred-dollar saddle on
a ten-dollar horse” — viewing the collaborative platform as overkill, which
in some cases may be legitimate. However, many of the smaller business units
are the fastest growing and most profitable operations.

For example, the “hundred-dollar saddle” scenario is a common position among
fledgling unregulated power generation business units. Given the rate of growth
and the level of competition, it is imperative that the decisions taken today
are mindful of the business operations and competitive landscape three to five
years from now. Otherwise, the threat of having integration and scalability
problems in the supply chain will be significant.