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Writing on the Roof: Competition for Electric Utilities

Suddenly, electricity appears too important to be managed by traditional electric utilities alone. The barriers to entry have fallen; a large number of new and old companies have entered the power generation business. How should the existing utilities respond? I believe they should enter the distributed solar-based generation business and offer new grid-integrated services.

Numerous and diverse competitors non-utilitieshave already entered the electricity business. Real estate companies and builders are offering rooftop solar, particularly on new homes. Schools, government buildings, and businesses are deploying their own solar panels. Chevron Energy Services, a division of the oil and gas giant, has begun installing solar panels in parking lots of California schools. Early adopter households are becoming their own micro-utilities and are moving toward energy self-sufficiency.

I have argued in earlier REW articles that IT and telecom companies have assets that position them as future energy companies. NRG Energy, with a solar division in California, is developing electric charging stations for automobiles – a new kind of “gas” station. A Deloitte paper has rightly observed that every company either is, or soon will be, an energy company.

Pressures: Technological Advance, Regulatory, and Climate Change

Significantly higher costs held back widespread deployment of distributed generation until now. Regulations set the benchmark for “grid parity” costs.  Solar companies, on average, have now breached those costs, thanks to global scale manufacturing of solar panels. This has opened the gates of competition. The well-recognized triggers of industrial mutation – technological advance, clustering of innovations, entrepreneurship, new opportunities, and the resulting creative destruction, now drive the competitive activity.

A worrisome driver affecting electric utilities might be the loss of their “natural monopoly” status from a regulatory standpoint and the benefits that derive from it. The classical arguments favoring it, namely, high barriers to entry, and “a single producer will be able to produce [electricity] at a lower cost than any two other producers” do not hold.  This has to be regarded as a distant threat.

Climate change arguments too may not be ignored any longer. The global boredom that greeted the recent Rio+20 Conference resulted from people’s feelings of impatience. People wondered what steps governments, corporations, or individuals would actually take to move us into the clean energy future. There is weariness with public policy; little has happened except talk for twenty years. In fact, of all players in the energy domain, existing electric utilities are best positioned to usher in the low carbon future, and they might do so as they pursue their self-interest.

Electric Utilities: Well-positioned but Handicapped

Charting this course would represent a major shift in strategy for utilities. Yet they should pursue distributed generation for several reasons. They have a) databases on customers and their usage, b) the infrastructure deployment and monitoring, and c) an understanding of solar and conventional technologies.

The business logic is clear, too. Utilities should enter distributed generation for defensive reasons – to sustain their revenue base. On the positive and leadership side, they have the opportunity to augment present revenue through tapping new customers, even outside their service territories, before others do. Can utilities offer solar deployment, monitoring, and maintenance at a competitive price? Can they define a business model that works?

If, however, the utilities adopt a wait-and-see approach, the solar behemoth will chip away at their revenues, household by household, at an accelerating rate, with the best customers going first. The best customers, of course, are those that pay higher bills because their consumption exceeds basic usage. These customers, sizeable in number, matter most to utilities. Unless the utilities retain their revenue, this loss will upend their economics.

Why haven’t the utilities entered the solar distributed generation business, both inside and outside their territories? My conjecture is because the changes in the industry have been too fast the past two years; there has not been enough time to digest the pace of events. Besides, whichever company embraces distributed solar first would be a pioneer; caution is understandable.

Business courage is needed. Legacy mindsets stand in the way – organizational histories, long-standing business cultures, and institutional memories. The past offers limited guidance, though appreciation of recent telecom history helps.

Telecom Parallels

About six weeks ago at my home in California, I received a call from a start-up headquartered many miles away, in the service territory of a different electric utility, asking if I would like to install solar panels on my rooftop, with no upfront capital cost, to reduce my electricity bill. They offered to qualify me and schedule installation on the spot. I expect many such calls from new and existing providers. That call should have been from my own utility, but they don’t have such a program, at least not yet. The call reminded me of the 1990s when phone companies used to call incessantly, hoping to persuade me to choose a new operator or international dialing plan.

#rewpage#

After the divestiture of the old AT&T in 1984, the Baby Bells (Bell Atlantic, Nynex, Southwestern Bell, Bell South, Ameritech, Pacific Telesis, and US West) became regional monopolies, and they could only offer local services. For long distance, they had to rely on inter-exchange carriers. Could the Baby Bells be compared to today’s electric utilities?

The old AT&T, MCI, and Sprint offered long distance or inter-exchange services. These networks may be roughly compared to the interstate transmission infrastructure of electric utilities. Some independents (e.g., GTE, Century Telephone, Rochester Telephone, and Citizens Utilities, often rural and smaller carriers) offered both local exchange and long distance services. There were notorious upstarts in the fray including WorldCom and Global Crossing. This regime did not last long when competition from digital cellular (Personal Communications Services) and new entrants, competitive local exchange carriers (CLECs), arrived. Could the new solar companies be compared to the competitive telecom entrants?

The result was telephone companies had to abandon their old organizational ways, as natural monopolies with geographically defined markets, and begin competing. The landline companies lost “minutes of use” and many customers to the wireless providers. The Baby Bells started buying each other and the long-distance carriers, eventually reconstituting themselves into the carriers of today. Verizon and the new AT&T are incarnations that have emerged in the aftermath of convoluted US telecom evolution. Will electric utilities of today undergo similar industrial restructuring – mergers and consolidation?   

Admittedly, the comparisons are preliminary, and more nuanced parallels may be drawn; nevertheless, two lessons from the history of the telecommunications industry stand out. First, we cannot predict in advance who will lead the transformation in the electric utilities business. It is instructive that Southwestern Bell of San Antonio dominated the rollup leading to the new AT&T, not any major city telecom giant. A company’s assets, location, and prominence today are no predictors of tomorrow’s leadership.

Second, rather than competing with each other, incumbents are likely to merge so that only a few operators compete nationally. Forming fewer companies, say 3 to 5, with national scope and scale, might be a good survival strategy post mergers and consolidation.

Strategy Time

Business strategy in the classical sense, as taught in business schools or purveyed by consulting companies, does not strictly apply to electric utilities. As regulated monopolies, they have unusual characteristics, including rate-of-return regulations, and must appease regulators as well as users and investors. They have attributes of both public sector enterprises and private companies. This mix has to change because, in the future, electricity prices will be set by markets through competition, as happens now with mobile telephone operators, rather than by regulators.

Utilities face the seemingly simple yet difficult strategy question: “What business are we in?” an issue they are unlikely to have previously confronted in their stable and predictable environment. Are utilities in the electricity, gas or energy business? Should they continue selling kilowatt hours, and should they also lease solar hardware, provide electricity storage, and provide grid electricity as insurance and back up?

Depending on the answers they choose, utilities may move inside homes, offices, and factories more than they ever have, and offer more services than kilowatt-hours. While futuristic, it is conceivable that they create service bundles that sell the benefits of electricity, for instance, illumination, comfort, refrigeration, heating, cooling, and motion, instead of kilo-watt hours. They could form partnerships with appliance makers, architects, and builders to craft new services, with “demand response,” energy efficiency, and information management solutions baked in. The unit of analysis might be a combination of the amount of electricity consumed and the performance attributes of the appliances. They may sell carbon-neutral services, e.g., a Zero Net Energy lifestyle. I believe there is scope for creative marketing.

Not all utilities will make the same choices. The need for competitive differentiation, as well as the threat to their revenue streams, makes fundamental business re-thinking critical. For if they do not define solutions, their competitors might; in fact, utilities may not lead the energy services revolution at all.

Which Companies Compete?

The entry of new firms specializing in distributed generation will, beyond a doubt, remake the electricity landscape. Yet the most transformative competition may be within the fraternity of existing utilities. Efforts to make competition manageable might result in a wave of partnerships, alliances, roll-ups, mergers and acquisitions. Unconstrained by geographically distinct service territories, existing utilities may seek customers everywhere, worldwide. 

Lead image: Solar panel on roof via Shutterstock

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