Utilities: dinosaurs looking up as the asteroid impacts?

 I was struck by a recent on-line headline; “utilities facing 50% reduction in demand”.  The origin of this was an excellent piece of research from Citi called “Energy Darwinism” which covers all forms of energy but the most eye-catching conclusions were about electricity.  The report notes how there is still a link between electricity demand and economic growth and population but in developed markets this link is weaker than it has been historically.  In addition, and to quote the report: “it is rapidly becoming evident that the potential for demand reduction is substantial and overall electricity demand could decline by more than 20% across Europe through energy efficiency” (my emphasis).  The combination of energy efficiency and distributed generation could reduce the addressable market for electricity by 50% over the next two decades.  This may be a surprising conclusion to some but it must be one that must be worrying utility CEOs everywhere.

 Here in the UK the energy suppliers are under attack from all sides and although I would never feel sorry for them (the pay and conditions are pretty good) being a utility CEO at the moment is a difficult job – those that are in charge in the next five to ten years have to face a massive set of interlocking challenges.   

 Firstly they are being asked by governments to invest massive amounts in decarbonizing the electricity system.  At the same time the effect of intermittent wind power makes it more difficult (impossible) to justify investment in flexible new gas-fired generating plant.  If we had cheap shale gas that might change but the availability and price of shale gas in the UK is far from assured – I don’t think we will really know how that story is going to play out for at least five years.   

Secondly, energy prices have gone up faster than inflation and continue to do so, leading to consumer complaints and the threat of direct political action to freeze prices from Ed Milliband.  The drive to decarbonization and the need to invest works against the political ideal of low energy prices.  In the UK at least, the existing main utility companies have completely lost the trust of consumers – a loss that will be near impossible to recover from. 

Thirdly, the organization of the UK electricity market is changing fundamentally and Electricity Market Reform (EMR) is finally coming.  EMR itself however, makes the investment environment even more uncertain – working against the basic idea which was to put in place the conditions that would allow the much needed investment to flow into new generating plant.  EMR also effectively gives the government the choice of technology.

 Fourthly, we have a technology revolution starting in energy efficiency, distributed generation, storage and new downstream markets.  I say starting because we still have a long way to go but new efficiency, solar, combined heat and power and storage technologies, possibly coupled with an increase in electric vehicles, all wrapped in a world of connectivity and big data, are all working together to increase the pressures on utilities.  This revolution is rendering their old business model obsolete by cutting the addressable market in half.

 Given all these forces the utility companies are looking more and more like wide-eyed dinosaurs looking up at the giant meteor or asteroid impact that sparked the Cretaceous-Paleogene extinction that killed them off – doomed to extinction. 

 Of course, the key to survival at a time of change is to evolve and evolve quickly – in business terms to innovate.  However, utilities are not traditionally good at innovation or moving quickly.  Even if the need for change is accepted, and the recent PwC utility industry survey suggests that 94% of executives surveyed predict “complete transformation or important changes to the power utility model”, the problem of how to get there from here is very real.  The fundamental issue is the age-old problem of changing the direction and culture of large organizations.  Since the advent of the large-scale electricity industry (starting in the 1930s) the organization of utilities, their systems and their skills sets have been based on building large centralized generating plants coupled with retail organizations with customer service and billing functions.

 The generation side of all utilities has a very high level of technical and project management skills based around the particular type or types of generating assets in the portfolio, be it coal, nuclear, gas turbines or renewables.  The people on the generating side are used to the problems of designing, building, commissioning, operating and maintaining large-scale generating plant which are very different skills to those required in energy efficiency or distributed generation work.  On the retail side energy suppliers have a mix of skills including, marketing, advertising, billing, customer service and meter reading – where this falls within their remit.  For energy suppliers the missing skill sets are those which are required to go beyond the meter and into the consumers’ premises to identify, implement and where appropriate finance energy efficiency and distributed generation projects.  These are skills that either need to be built in-house, bought in through corporate acquisition, acquired through appropriate partnering or outsourced to third parties. 

 Senior management in utilities has grown up in the old world of utilities which were stable and the objective was to maximize supply volumes. They are not so familiar with the technologies, techniques, contracts and risks concerning demand-side projects.  Senior managers of publicly quoted utilities also have to consider the opinions of their major investors and the impact of any change of strategy on shareholder value.  Utility investors are traditionally interested in relatively low but safe returns and, whatever the facts, they may not consider a switch into different services with different issues and risk profiles as something they want to see.  Any proposed change has to carry major shareholders with it. 

Even if the companies are ready to innovate, the question still remains – how should they innovate?  New business models are required that integrate; improvements in energy efficiency (building and industrial retrofits), distributed generation, storage, access to grid electricity, connectivity and financing.  All of these need to be wrapped up into propositions that are attractive to customers – relying purely on cost savings is not enough.  Despite the fuss about energy bills for most people saving money on energy is desperately dull – it is not “cool” – the new energy services have to be cool to attract a mass market.

 The ultimate model held out by energy efficiency enthusiasts is the true energy service company, a company that only provides services such as set standards of illumination or thermal comfort and is not selling energy in the form of electricity, gas or oil.   Such a company would be motivated to invest in the most efficient methods of delivering energy services.   To date there have been no real examples of true energy services companies and it represents a massive leap from where most energy suppliers are and a real departure from their core skills.  However, it does represent a more radical alternative than just bolting-on energy efficiency services to an existing energy supply model, but reaching this ideal – or any other new model – raises a number of questions for a utility such as:

•  Should it start new businesses, or acquire existing businesses? 

•   Should the new business models be within existing organizational structures or outside in some kind of incubator?

• If it acquires existing businesses, in which sub-sectors of energy efficiency markets and distributed generation should these be?

•   How should these different businesses be integrated into a holistic customer offering?

We have seen examples of utilities going on spending sprees to acquire companies in different areas of energy efficiency such as Building Management Systems and home automation, possibly without any coherent plan for how these can be knitted together.  As well as the questions above there are the normal business acquisition problems such as how do you integrate dynamic, entrepreneurial small to medium sized companies with the typical, safe, slow, bureaucratic structures and systems found in utilities?  Initiatives such as community energy companies can raise even more difficulties as they often require a transition from a mind-set of “we have all the answer” to facilitating other groups to find multiple and diverse solutions.

 Of course the existing energy companies may not be left to choose whether or not to innovate – the industry is ripe for disruption from new entrants.  Personally I wonder if the existing companies can innovate in time before new entrants come in and disrupt the market entirely.  New entrants could include well-known brands that do still have customer trust, multiple “touch points” with the customer and advanced technology around the internet and communications – without all the technological and social baggage of the existing companies.  New ownership models including community ownership may also be disrupters.

 In the next few years we will see utilities split into two groups – the majority run by CEOs who basically, whatever their public relations utterances, try to defend the existing model – the followers  – and the real leaders, those that have CEOs who having recognized the need to radically change the business model have the courage and skills to actually try to implement those changes.  Changing the existing companies will require strong leadership from the top or the existing companies will disappear, disrupted out of business by exciting new entrants who, unburdened by history, seize the massive opportunities of efficiency, distributed generation and energy services.