Forces of Change in the Energy Industry

The networked information economy and competition represent two of the greatest
drivers of change in the energy industry today. While the growth of business
information networks provides the framework and infrastructure for companies
to prosper, restructuring drives the fundamental “shape” of the industry. These
forces together define the strategic imperatives and opportunities facing energy
companies, as well as a company’s place in the energy value chain and its role
as part of a larger business information network.

The concept of the networked information economy has quickly evolved from the
increasing connectivity among people and organizations. The value of information
has grown exponentially over the past two years. While this includes the use
of enabling technologies, such as the Internet, dispersed technologies and wireless
devices, the real value of connectivity goes beyond these. The networked information
economy was born from realizing the importance of information and the need and
ability to not only share that information, but to also use it to create business
value. Because of the ability to quickly and securely exchange information,
companies are no longer compelled to provide all functions internally and instead,
can rely on outside organizations that can provide the service more efficiently
and effectively. This has enabled the growth of business networks, allowing
companies to focus on specific roles according to their competencies and assets,
both physical and information. Some immediately apparent advantages are streamlined
online purchasing, online energy trading, and enhanced contact with customers
— each involving distinct roles in a business information network.

Perhaps less obvious is that the networked economy proves to be a key enabler
for the leveraging of both physical and non-physical assets. By providing a
community in which information can be instantly transmitted and used strat egically,
companies that have traditionally relied on physical capital have been forced
to re-think their idea of assets. Companies may conclude that their highest-return
assets are human, information, or brand-based, and will decide to de-emphasize
the role of physical assets in their businesses.

Figure 1 – The Traditional Business Model

On another front, competition resulting from restructuring on the wholesale
and retail markets has driven the unbundling of the vertically-integrated energy
value chain. This unbundling results in energy companies assuming one or more
distinct business “paradigms” or adopting specialist roles within these paradigms.
Using the traditional vertically-integrated electric utility as an example,
we have witnessed the separation of the generation, transmission, and distribution
components. Secondary unbundling has taken this separation a step further by
spurring the creation of external enterprises to perform those functions once
conducted in-house by the traditional utility, such as maintenance of generation
plants and distribution lines, supply chain functions and information technology
operations.

Strategic transformation in today’s energy industry requires that a company
understand these forces, undertake a methodical approach to identify where it
can best compete, and specify those actions it must take to compete success
fully. The ideas that follow present our view of how the industry and business
landscape will continue to evolve, and lay out an approach for converting strategic
ideas into actionable projects.

Business Roles in the Networked Economy

The traditional business model for companies in all industries emphasized reliance
on physical assets, the ownership of production, and vertically integrated business
segments across individual supply chains (Figure 1). Companies competing with
the traditional model exhibited limited information sharing and transfer, capital
ineffic iency with an emphasis on the balance sheet versus the income statement,
and often thinly spread management focus across several different business areas
within the vertically integrated enterprise. Individual companies conducted
business with each other, but also sought to be self-sufficient in most of the
business functions. This model emphasized individual performance versus that
of the market as a whole.

In the emerging business model, companies exist as part of an interconnected
business network, and focus on those functions consistent with the greatest
assets and capabilities (Figure 2). The emerging business models reward companies
that emphasize not only physical capital, but which concentrate on human, information,
and brand capital in their core competencies. For example, a service-focused
company would own relatively little in terms of physical assets, but would create
value by possessing detailed knowledge (e.g., technical or engineering knowledge)
and delivering superior service.

Figure 2 – Focus Areas in a Business Information Network.

As a company begins to embrace the power of the electronically connected business
network, the focus of the company’s operations will also change. Where previously
a large investment in physical plant would drive to focus on the operation,
maintenance, and full utilization of its assets, the networked community of
core business focus areas enables a company to concentrate on its strengths
by allowing it to shift non-core functions to other network members. This in
turn rewards the other network members for focusing on their core skills. The
connectivity afforded by the digital economy further allows network participants
to freely exchange information, enabling streamlined processes with customers
and suppliers as a result of easy information sharing, providing for more liquid
and transparent markets, and allowing for the easier formation and maintenance
of alliances.

The business network roles outlined in Figure 2 can serve as a useful management
tool by prompting executives to ask, “from what resources (assets and/or competencies)
does my business seek to extract value?” Business information network focus
is the answer to this question.

As an example of the possibilities for energy companies afforded by a business
network, a regulated electric distribution company would be enabled to pay greater
attention to customer service while shifting the maintenance of its wires network
to an external enterprise. In addition, a Web site can be established where
customers can pay their bills and submit service orders, the company can purchase
power and supplies via online markets, and the service crew can update service
orders instantaneously via handheld wireless devices connected to the work management
and customer information systems.

In another example, the New Power Company has used alliances to enter the retail
energy products and services space as a brand-focused company. By forming alliances,
the company can leverage the unique skills of its network members. In this example,
Enron brings trading and risk management skills for power procurement, IBM provides
back-office information systems installation and operation expertise, and AOL
Time Warner supplies expertise in online marketing and access to its large customer
base.

Industry Structural Change and the Five Dominant Paradigms

The traditional utility value chain focused on the regulated provision of energy
commodities to end customers. Natural monopoly status, a holding company structure,
and the pursuit of scale efficiencies all served to ensure the tightly bound
and physical asset-intensive nature of integrated electric utilities.

However, competitive and restructuring energy markets are resulting in the unbundling
of the traditional value chain into distinct roles (Figure 3). PricewaterhouseCoopers
believes that the structural evolution of the energy industry will further drive
the integration of certain roles, resulting in five dominant market paradigms
— Merchant Energy Companies, Major Account Retailers, Mass Market Retailers,
Network Distribution Companies, and Transmission Companies. These dominant paradigms
will be supplemented with other emerging paradigms over the information network.
Companies will not always position themselves in a single paradigm, but may
choose to compete in more than one.

Figure 3 – The Utilities Role Map

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The integration strategy “rolls up” several industry roles to form one of the
five dominant business paradigms. Some companies may take this strategy a step
further by integrating whole paradigms (Duke Energy and AEP provide examples
of companies that successfully compete in more than one paradigm). This strategy
leverages a company’s unique advantages with customers and regulators and its
unique energy market insight. Such a strategy rewards a focus on planning and
integration, and requires that a company leverage its most valuable assets (e.g.,
brand), strengthen its partnering skills, and outsource non-core functions to
specialists.

In addition to the emergence of these paradigms, we expect to see companies
focus on single roles within these paradigms. This type of strategy requires
world-class capabilities. This will ultimately lead to service paradigms across
industry boundaries.

Alignment of Business Focus Areas and Industry Paradigms

Energy companies are beginning to execute two core strategies as they align
with the business focus areas and adopt specific paradigms. The linkage between
the business focus areas, paradigms, and roles is shown in Figure 4 along with
specific company examples.

Figure 4 – Alignment of Focus Areas and Paradigms

Adopting a Brand Focus

Major Account Retailers and Mass Market Retailers represent energy company
paradigms that assume the brand-focused business and information network focus.
Such companies have emphasized the value inherent in their brand and information
assets while de-emphasizing the role of physical assets in their business. In
effect, Major Account Retailers act as industrial marketers and Mass Market
Retailers as consumer marketers.

Several attributes have been identified as providing superior advantages for
brand-focused companies. The economic drivers of value for these companies are
twofold — they must strive for economies of scale to achieve purchasing
leverage, and they also need economies of scope to provide a wider range of
products and services to retail customers than a traditional utility. Key financial
value drivers for such companies include margin size and revenue growth.

Resources leveraged by brand-focused companies are the company’s brand value
and human capital, both of which provide invaluable intellectual property resources.
They rely on customer and business network relationships, and as a result must
have unsurpassed skills in customer relationship management, channel management,
product development and marketing, and alliance development and management.

Brand-focused companies deal with physical energy and energy- and home-related
products and services, and have the potential to reach a variety of markets.
Deregulated retail electric and gas com-modity sales to residential, commercial,
and industrial customers is typically the path of least resistance for many
traditional utilities, and is therefore the most probable path taken by brand-focused
companies.

The sale of energy products to residential markets is quickly becoming an area
into which many companies are diversifying. Energy-saving devices such as plug
attachments and time-of-use meters, energy- efficient products such as light
bulbs and air filters, and energy-related products such as power packs are just
a few of the products that brand-focused energy companies have begun to sell.
Residential and commercial services represent another potentially large market.

A multitude of services can be provided to this market, including appliance
maintenance and home improvement, appliance warranties and financing, and residential
and commercial energy audits. Branded financial and “network” products are yet
another example of markets brand-focused companies have entered, with companies
offering credit cards and bundled electric, gas, telecom, and cable service.
Using brand as a key lever allows these companies to effectively cross-sell
products and services.

Adopting an Asset Focus

Asset-focused energy companies do not necessarily de-capitalize to the extent
that a brand-focused energy company would. Their success depends on economic
and efficient deployment of their physical assets. Such companies include the
Transmission and Network Distribution Companies’ business paradigms.

Like brand-focused companies, companies that pursue an asset focus need to emphasize
economies of scale to achieve the lowest possible costs. Those pursuing an asset-based
strategy, however, do not seek economies of scope, but instead focus on operational
efficiency and knowledge of the evolving regulatory structure. The key financial
drivers for those adopting an asset-focused role are net margin, capital expenditures,
and capacity utilization.

Resources leveraged by asset-focused companies are physical assets such as generation
plants, gas pipelines, and transmission and distribution networks. Critical
success factors include sharply honed skills in asset operation, maintenance,
and management, construction management, and active management of the regulatory
process.

Transmission and distribution owner/ operators serve the residential, commercial,
and industrial markets. Other markets for asset owners include fuel storage
and transportation (e.g., pipeline operators and wholesale fuel sales) and meter
ownership and servicing (e.g., in residential, commercial, and industrial sectors).

Adopting an Information Focus

Information-focused companies create value by leveraging information to manage
risk and ensure optimal deployment of their own physical assets. By using information
to create more transparent and efficient markets, the function of a business
network manager is being served. The merchant generator provides an example
of the first use of information, while an electronic marketplace for power and
fuel or equipment procurement provides an example of the second.

Merchant Energy Companies need to emphasize scope in the types (e.g., spot and
forward power prices, fuel prices, etc.) and sources (e.g., geographical) of
information from which they gain the greatest insight and benefit. They must
have the skills to analyze and act on what they collect. In the case of a merchant
generator, this means having the skills in trading and risk management to determine
when to optimally deploy their generation resources and to identify the most
promising markets for sales. It also means having the ability to mine collected
data in order to develop new risk management tools and techniques.

The resources and skills required for information-focused companies are top
human talent possessing the requisite skills, and information technology capable
of capturing, storing, and manipulating the vast amounts of data such companies
use.

The products and services rendered by information-focused businesses like Merchant
Energy Companies are power sales to the wholesale market, from either their
own generation plants or procured in the wholesale market. Merchant Energy Companies
may also develop new risk management products for their own use, or offer risk-related
products and services to external customers, such as risk structuring. Business
network managers, such as Intercontinental Exchange, offer a market where buyers
and sellers can meet and exchange energy-related commodities such as power and
fuel, while companies like Pantellos deal in “hard” plant- and network- related
equipment.

Adopting a Service Focus

Service-focused companies in the purest sense pursue a strategy by adopting
only a limited number of roles from the Utilities Role Map©. Representative
roles are a constructor of generation, transmission, or distribution, a maintainer
of these assets for the owner, a customer service provider such as an outsourced
call center, or a billing agency. These are the companies in the business network
to whom asset-focused players such as distribution companies outsource their
non-core functions.

Such companies can benefit from serving clients over a wide geographic or even
global scope, since a critical mass of clients may be difficult to obtain in
a single region. World-class skills and technical knowledge of utility-related
equipment and processes are a necessity, given their service orientation.

Preparing for Execution — The Transformation Blueprint

Understanding industry and business dyna mics and finding where one’s company
should compete is only half the battle — assembling the necessary skill
set remains. To do this, we use the Transformation Blueprint to map the critical
success factors for a given paradigm or specialist role against fundamental
business dimensions (those elements that combine to form a business, such as
processes and people) to identify a comprehensive development program for transforming
a company. The blueprint’s output is a portfolio of projects that a company
would need to undertake to be successful in a given paradigm or specialist role.
Identifying specific projects that link directly to the critical success factors
moves a company from strategy to execution, and ensures that the projects undertaken
fit the chosen business model.

PricewaterhouseCoopers has developed a Transformation Blueprint for each of
the industry paradigms. Figure 5 shows an illustrative example of a blueprint
for a Merchant Energy Company. While the actual projects undertaken will depend
on the specific company in question, the blueprints serve to highlight the types
of projects and skills needed for a given strategy and business model.

Figure 5 – Illustrative Transformation Blueprint – Merchant Energy

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Conclusion

The energy industry is in an enviable position — it is undergoing profound
fundamental change at a time when technology offers possibilities never before
seen. Strategic transformation in today’s environment requires that a company
understand the forces re-shaping the industry and those forces driving change
in the greater business landscape. The ideas presented here offer a disciplined
and unified approach for understanding how the industry will unfold, the distinct
business models enabled by technology, those specific capabilities a company
must have and the actions it will need to take today to initiate its transformation.

Many energy companies have begun to embrace the opportunities made available
to them by these changes; others must begin to view their businesses less as
part of a murky regulated backwater and more as mainstream organizations with
assets and capabilities that stretch beyond power plants and load forecasting.
The opportunities and enablers are already there — seizing them is the
next step.