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

Case Study

Confronted with many of the challenges presented here, a major energy company (MEC) with global operations decided that it was time to take the issues on and to determine the opportunity for achieving synergies across its business operations. At the request of MEC executives, the MEC completed an analysis of the broader operations and they identified several major opportunities for reducing costs. One of the key opportunity areas was strategic sourcing and supply chain integration. The MEC faced many of the challenges discussed here, but the chief procurement officer quickly bought in to the potential benefits. He set out to elevate the procurement function to a strategic level, whose primary goals were to facilitate collaboration across the supply chain and to optimize positions with strategic suppliers. The MEC engaged a professional services firm to complete a strategy for supply chain collaboration and to work with the MEC to develop an enterprise supply chain “footprint” that could be scaled to support large and small business operations. The six-week intensive effort involved a core team of six MEC staff and three consultants who focused on data collection and facilitated workshops with executives, key operations management, and key end-users. A number of obstacles were encountered, including skepticism among the business units about collaboration, concerns about the ability of a single technology platform to fulfill diverse needs, and cultural bias against a truly transformational effort. However, through executive leadership and open communications, the organization agreed on a common enterprise framework that met the needs of all key business units. At the end of the six-week effort, the MEC had a solid agreement among the business units to work together. The MEC has selected an implementation partner and is now in the design stage of the effort. The payback for the implementation begins within nine months of establishing the enterprise supply chain “footprint.” With a clear understanding of how the intra-organization supply chain functions will work, the MEC is now focusing on incremental opportunities to drive out additional value through optimizing tax liabilities in procurement and inventory management restructuring. Candidates for external collaboration are being short-listed and pilots for supplier or commercial/ industrial customer integration are also being considered. By the end of 2002, the MEC will be among the top supply chain operations in the utilities industry and other industry sectors. Moreover, it will have a foundation for continuous refinement and for expanded collaboration that will well position it for navigating through any future challenges that competition may bring about. The company definitely plans to be a survivor that prospers through “tough” times.

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.

Introduction

The past few years have brought about many sweeping and costly changes to the
energy industry. Post-merger power companies in particular are reeling in a
business climate inundated with complex issues. The unexpected effects of deregulation,
convergence, Web-enabling technologies, and the advent of new competition via
new spin-offs and fresh start-ups has merged and/or acquired businesses wondering
how to achieve and sustain the speed, effectiveness and value to realize post-M&A
IT integration.

Most businesses think that the right solution is to seek economies of scale
via the elimination of process redundancies that will, in turn, allow for a
significant reduction in labor costs. But the truer, perhaps longer lasting,
solution is the one that provides the right mix of process, application and
emerging technologies, and combines them with effective program management of
the entire process. In order for program management to be successful, a clearly
defined set of integration initiatives or projects must be thoroughly planned.
This initial planning is critical to the success of the merger, because it aligns
the strategy, processes, organization, and technology of the companies to help
ensure they achieve the merger’s objectives.

How long after a merger or acquisition should IT integration be considered?

IT integration planning should begin during the due diligence process. It is
critical that the costs and savings associated with IT integration are assessed
in great detail when organizations consider the feasibility of a potential merger.
The reality is that M&A integration costs associated with IT (both infrastructure
and application integration) are usually 45 to 65 percent of the integration
budget, and can account for as much as 35 to 55 percent of the synergistic savings.

Although it is difficult to quantify the American energy players currently working
on post-M&A IT integration initiatives we can certainly say that:

1. Every one of these companies will have undergone some type of post-merger
activity during the transitional period; and

2. Most IT integration activities continue 12 to 24 months after the merger
is closed, depending on the level of integration that is sought.

How does a company determine priorities and then develop a game plan?

In a typical merger, IT integration activities can be classified into three
broad categories: process, application, and infrastructure. Process integration
activities are focused on identifying common or new business processes that
will be employed by the combined organization. These process definitions then
need to be supported through an integrated set of applications. For example,
a common, centralized accounts payables process is identified while an integrated
AP application (usually in the form of an ERP) facilitates the fulfillment of
these processes. The third component is ensuring that the technical infrastructure
is available to enable the application integration. In this example, network
connectivity and bandwidth would be critical to support a high-volume common
AP environment.

The integration project itself should follow a five-step approach:

 

Understand Strategic Positioning

Without a doubt, solid leadership is the most important key to success and
must be identified and fully dedicated from day one. These leaders will institute
the strategic vision of the organization. This will enable the project team
to align the strategic objectives in processes, application and infrastructure
with the planned IT integration initiatives to achieve the defined synergy savings.
Key business and technology leaders are also identified and formal decision-making
and governance processes are adapted.

Synergy Validation & IT Review

Here, team leaders review the identified synergy savings figures with the appropriate
integration team members. This information will be critical during the cost
and resource review phase, as significant cost justification is usually required
to proceed with IT integration projects. A critical component to the overall
IT initiative-planning effort is identifying the estimated capital and recurring
costs for each integration project. Since a significant percentage of this cost
typically involves technical infrastructure-related items (e.g., hardware, network
upgrades), it is important to have a comprehensive understanding of the current
IT environment for both organizations.

 

Figure 2 – Synergy savings cannot be achieved without fully aligning all parts
of the integration effort.

Develop Integration Plans

During this phase, the team will assess and evaluate each integration project
for impacts, dependencies, and cost factors in several areas including business
processes, infrastructure, applications, and data security. A detailed work
plan is developed that includes complete resource-loading, skill set requirements,
and dependency identification. A risk assessment for the project is also developed
that documents risk-mitigation suggestions and contingency plans if appropriate.
Once a detailed initiative plan has been reviewed and accepted, it is linked
back into the overall IT master schedule.

Cost & Resource Review

A human resource plan is developed and determinations are made in regard to
future staffing needs. While the estimated cost for the integration projects
and the potential synergy savings were documented and reviewed during the integration
planning phase, here these costs are reviewed from an overall perspective. If
a significant variance exists between the initial synergy savings and cost estimates
and the values produced by the project team, the estimating metrics and cost
factors are revisited and appropriate adjustments are made.

Implement

Now it’s time to see if all of the analysis, preparation, leadership decisions
and project plans have paid off — it’s time to implement. Leaders will
execute their organization’s realignment communication plan and implement all
targeted organization, process, and technology changes, including e-business
tools. Business process validation is conducted and KP/CIs are tracked. Post-implementation
support is also provided as necessary.

It is important to note that while the overall approach to a post-M&A IT integration
is often the same, the decisions of what to integrate differ between organizations,
and rely largely on both strategic business decisions and the amount of synergy
savings enterprises have agreed to deliver to stakeholders.

What is the time frame for a typical post-M&A IT integration effort?

Of course, this number varies according to the level of integration achieved,
whether all of the projected targets were accurately met and if schedules were
strictly enforced. However, for optimal results, integration planning should
begin during the due diligence process (pre-deal) and should be completed 18
to 24 months after the deal is closed. Activities that extend beyond 24 months
of post-close may not be considered true integration activities.

 

What are the pros and cons of a comprehensive IT integration?

Although it is somewhat difficult to completely categorize results as either
pro or con, outcomes could be considered as perceived rewards, and the risks
and challenges commonly associated with a comprehensive IT integration.

Most evident are the rewards that come in the form of bottom-line, hard savings
derived from FTE (full-time equivalent) reductions that could only be achieved
through comprehensive systems consolidation. IT operation, and operation and
maintenance (O&M) costs are substantially reduced. Another equally tangible
benefit is that common business processes are more easily enforced through common
systems.

Still, risks and challenges need to be carefully considered. It is quite possible
that integration activities might take as many as two to three years to complete
— diverting resources from new business ventures during this time. IT integration
also commands an up-front investment, and a strong business commitment is critical
to undertaking a successful IT integration project.

What are expected cost savings?

Cost savings can typically be divided into two areas: core IT savings (e.g.,
data center consolidation, platform consolidation, etc.) and business savings
from IT integration/consolidation (e.g., FTE reductions from consolidating the
AP department into a single system).
Business savings are usually directly related to the synergy savings documented
in merger filings. With the regulated utilities, additional savings are often
considered “bad” because they need to be passed on to ratepayers and cannot
be retained and/or reinvested by the organization. For example, while one merger
recently agreed to deliver $170 million in savings over three years with $100
million in the first year, another has said that they will deliver little or
no savings.

What key metrics are put into place to measure success?

A key metric is the ability to achieve targeted synergy savings. This can be
measured, for example, through FTE reductions or the ability of the organization
to successfully function under the reduced post-merger budget. Often, individual
integration projects will develop their own set of metrics. For example, a consolidation
of a financials system may have a metric of reducing the monthly closing cycle
by two days.

How much does a large-scale integration cost?

In our experience, we have seen such projects range from as little as $15 to
20 million to many more tens of millions of dollars, depending on such diverse
factors as the size of the merged organizations, the level of integration needed,
the anticipated savings from FTE reductions and consolidation of infrastructure/processes,
and the levels of technology to be instituted.

All post-M&A IT integration teams must focus on two things: capturing the benefits
and integrating the business. In order to capture the benefits, the enterprise
seeks to achieve business value goals as quickly as possible by driving short-term
value and exceeding the market’s expectations. Integrating the business essentially
translates into a seamless implementation of combined day-to-day operations
and positioning the enterprise for future growth.

Success is evident when the newly merged business can produce prioritized plans
to reap the benefits and post-merger integration checklists. Misalignment between
the IT initiatives and the overall business strategy, process, and organization
will prevent the realization of synergy savings. With a sound strategic enterprise
architecture approach, proper alignment can be achieved, resulting in realization
of the synergy savings.

Summary

Post-merger IT Integration can often be the Achilles heel of merger integration;
however, it also offers the potential for enormous value creation. Planning
for IT integration must begin during the due diligence process and a target
budget should be established. This budget should be balanced with the amount
of synergy and cost savings that have been identified. By following a structured,
methodical approach to IT integration that involves the appropriate alignment
of business strategy, process, organization, and technology, the organization
can reap the benefits of — and capitalize on — the post-M&A IT Integration.

“Lessons learned” that we have passed along to clients

1. Synergies are always initially overestimated and the effort to achieve them
is always underestimated.
2. Top management must support the business objectives that drive IT application
decisions.
3. The IT integration process will always take longer to complete than originally
estimated. The biggest delay comes from the business’ inability to make timely
decisions. Understand your dependencies and be able to clearly articulate them
to management.
4. Start contract negotiations with software/hardware vendors earlier. Don’t
wait until after close when time is no longer on your side.
5. Have a clear understanding of the cost breakdown for each integration project;
you will be asked multiple times to justify and/or revise them downward.
6. When planning integration projects, have a clear view of the resource requirements
and constraints for each organization. Do not over-allocate them.
7. Business decisions must drive application integration decisions. A balance
must be achieved between operational efficiency, implementation costs, and synergy
savings.
8. Communication is critical. You can never overcommunicate.
9. The close date can change two or three times. Have a flexible plan that can
easily be modified to different scenarios.
10. Don’t underestimate the resistance and negativity you will get from the
acquired organization. This must be monitored through a change management process.

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

See Larger Image

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

See Larger Image

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.

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

Case Study

Confronted with many of the challenges presented here, a major energy company (MEC) with global operations decided that it was time to take the issues on and to determine the opportunity for achieving synergies across its business operations. At the request of MEC executives, the MEC completed an analysis of the broader operations and they identified several major opportunities for reducing costs. One of the key opportunity areas was strategic sourcing and supply chain integration. The MEC faced many of the challenges discussed here, but the chief procurement officer quickly bought in to the potential benefits. He set out to elevate the procurement function to a strategic level, whose primary goals were to facilitate collaboration across the supply chain and to optimize positions with strategic suppliers. The MEC engaged a professional services firm to complete a strategy for supply chain collaboration and to work with the MEC to develop an enterprise supply chain “footprint” that could be scaled to support large and small business operations. The six-week intensive effort involved a core team of six MEC staff and three consultants who focused on data collection and facilitated workshops with executives, key operations management, and key end-users. A number of obstacles were encountered, including skepticism among the business units about collaboration, concerns about the ability of a single technology platform to fulfill diverse needs, and cultural bias against a truly transformational effort. However, through executive leadership and open communications, the organization agreed on a common enterprise framework that met the needs of all key business units. At the end of the six-week effort, the MEC had a solid agreement among the business units to work together. The MEC has selected an implementation partner and is now in the design stage of the effort. The payback for the implementation begins within nine months of establishing the enterprise supply chain “footprint.” With a clear understanding of how the intra-organization supply chain functions will work, the MEC is now focusing on incremental opportunities to drive out additional value through optimizing tax liabilities in procurement and inventory management restructuring. Candidates for external collaboration are being short-listed and pilots for supplier or commercial/ industrial customer integration are also being considered. By the end of 2002, the MEC will be among the top supply chain operations in the utilities industry and other industry sectors. Moreover, it will have a foundation for continuous refinement and for expanded collaboration that will well position it for navigating through any future challenges that competition may bring about. The company definitely plans to be a survivor that prospers through “tough” times.

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.

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

See Larger Image

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

See Larger Image

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.