“After ten years of cost cutting there comes a time where you need to look for more innovative responses to having your income reduced,” comments 24seven’s Richard Harpley, summing up the frustrations of distribution network operators in the UK and the motivation for London Electricity and TXU Europe to form 24seven, a joint venture to run their power networks.
Formed in December 1999, 24seven had a clear remit: to operate and manage London Electricity’s and TXU’s distribution networks, and achieve cost savings and efficiencies through economies of scale and best working practices. Its creation was seen as an innovative and creative solution to the increasingly tough operating conditions being imposed on power network operators by Ofgem, the UK regulator.
While the UK’s electricity market is fully deregulated, the natural monopoly of distribution network ownership remains regulated. The 14 Public Electricity Suppliers (PESs) obtain their income by charging third parties to use their networks. The prices they charge are controlled by Ofgem, and in recent years the companies have seen their margins increasingly squeezed.
In August 1999, Ofgem announced a new round of price reductions for PESs for 2000-2005. The proposals were tough an initial reduction in prices of up to 30 per cent followed by an annual below-inflation price cap but were designed to force the PESs to realise greater efficiencies without harming supply standards and investment in the networks.
While TXU Europe (formerly Eastern) was one of the most efficient of the PESs, and London Electricity was an above-average performer, both companies had price cuts of around 30 per cent imposed.
But even before this price review, both London and TXU had begun to realise that their network ownership business would see only a reduction in revenues over time; in their current structure and situation, growth would not be possible. Harpley, business strategy director of 24seven, explains: “We started to think about what our core competencies are and how we could grow the business rather than perpetually cutting it down to size. What we concluded is that there is no real specialist competence in owning all the assets … what is special is how you manage them. That is the thing that the regulator saw as being at the frontier of performance.”
The business model behind 24seven was therefore born: splitting the distribution unit in two a network ownership division and a management division. While returns in the ownership division would continue to decline and at some point level off, TXU and London saw the management unit as an area that could achieve growth and bring high returns. By implementing this model jointly, economies of scale would help achieve the cost savings and efficiencies required by Ofgem’s price review.
So in December 1999, London and TXU announced the formation of 24seven a stand-alone, equally-owned joint venture to operate and maintain the two companies’ distribution networks. On announcing the venture, Phil Turberville, CEO of TXU Europe, said: “This joint venture is ground-breaking in the UK. It is the correct business response to the challenges of the tough Ofgem price control while delivering further improvements in customer service.”
24seven’s parent companies have retained ownership of their network assets and hold the license to distribute electricity.
24seven’s role is purely operational: its remit is to develop network strategies and asset management plans, manage and develop infrastructure, operate and maintain the network and arrange connections, investment planning and customer relations.
Crucially, 24seven is kept totally separate from its parent companies. According to Harpley, a simple internal separation would not allow the objective of growth to be reached. “[Internal separation] would just be another boundary,” said Harpley. “What you need to do is create a dynamic that is the beginnings of growth and the beginnings of serving more than one customer. That introduces commercial drivers to the business that you don’t have in normal regulated utilities.”
The distribution network now operated by 24seven serves around 5.3 million customers, and 24seven employs around 2500 people. Prior to the venture, TXU employed 2000 personnel to serve 2.3 million people, while London Electricity employed 1500 people.
Job losses have therefore occurred through the merger, mainly in office and administrative functions rather than in front-line engineering staff. This, as well as the combination of back office functions and improvements in asset management and network control operations through the installation of new IT systems, has already brought cost savings to 24seven, and will continue to do so over the next few years. “The thing that has made the biggest difference, though, is the existence of commercial contracts … which you can’t create internally,” says Harpley.
As it is operated as a separate company, 24seven holds commercial contracts with both TXU and London Electricity. This, says Harpley, has forced a change in mentality from a traditional public utility supplier mindset to being commercially aware of performance and client needs under its contracts with its parent companies, 24seven must perform to receive income.
“Because we’re under contract, if we don’t deliver what we decided was necessary under the investment plans for our customers, we don’t get any money. So there is only one thing we can do, and that is what is right strategically for our customers. For the first time ever, we have commercial alignment with the regulatory and corporate objectives of these companies. You can’t create that commercial tension [internally], and so we’ve been able to change behaviour.”
The contracts between 24seven and its parent companies are for five years, with a one-year renegotiation term at the end. There is also an exclusivity clause, which has been limited by the European competition authorities to three years. 24seven is now nine months into these contracts.
The contracts are largely fee-based with a series of key performance indicator-related payments. The fees relate to service provision, project work and critical work carried out on the network. The key performance indicators are aggregated and if targets have been met or exceeded, 24seven is rewarded. If performance falls below the targets, however, then 24seven has to pay penalties.
The performance rewards are scaled, so that the better the performance, the higher the reward, but only up to a certain level. A similar system operates with the penalties, but there is no cap penalties can be as high as performance is bad.
According to Harpley, this system mirrors regulation: “If you own a multi-million pound asset and it’s regulated, while you’re keen to see the costs of managing that network go down, you don’t want the performance to deteriorate, particularly in the UK where output-based regulation is becoming more prevalent. So in the contracts we are trying to mirror the content of output based regulation by having output as a key indicator for our performance.”
Managing the assets
Key to 24seven’s success and performance are IT and asset management systems. The company is working towards the centralization of London Electricity’s and TXU’s network control centres into one location. The operation of part of London Electricity’s network, including fault call handling, is still done from London Electricity’s control centres, but will be moved by the end of 2000.
There are three main aspects to 24seven’s operational systems: the network control centre, an integrated finance and work management system, and an asset register system. Within 12 months, the company will have all aspects of these fully commissioned.
24seven is now in the final stages of installing the centralized control centre at TXU’s old control centre in Ipswich. From here the entire network will be monitored and operated in real time through the use of a network management system.
In addition, an asset register has just been installed to help manage network assets. This system is a brand new installation and is configured to take on board asset condition information. According to Harpley, most asset registers are fairly constrained in terms of the amount and type of information they can store and use, but with this system, information is available on the condition of the assets which allows 24seven to make better decisions regarding investment planning.
The integrated finance and work management system will be complete in around 12 months’ time. The purpose of this is to have a complete end-to-end resourcing tool which will allow 24seven to schedule resources, collect costs of work and make related charges, manage accounts and produce reports for regulatory purposes. “A complete service, if you like, that ensures that we are able to service multiple customers, multi-utility and deliver through our contract information that is vital to their regulated business,” comments Harpley.
While waiting for the implementation of these systems, 24seven has had to rely on several legacy systems to carry out its work, and will continue to do so until these systems are fully commissioned. The use of several legacy systems has put additional pressure on staff. Nevertheless, says Harpley, this phase has been a good experience for 24seven as it is a process that it will probably have to repeat when it takes on new customers in the future.
24seven’s aim is to use its core competencies and skills to operate utility networks for other customers. Harpley says that 24seven has to keep TXU’s and London Electricity’s networks at the frontier of cost and quality performance, and it now wants to achieve this for other companies. It believes that its skills efficient management of network infrastructure are generic to the utility industry as a whole, and are transferable across water, electricity and gas networks.
“Our core competence is not putting a cable in the ground or building a substation … anyone can do that,” comments Harpley. “Our core competence is risk management and policy and operation, and the tools and techniques we use for that are not unique to electricity, they are unique to utility-type activity. They are tools and techniques for managing infrastructure.”
Other skills essential to its success include understanding its customers’ drivers, including regulatory issues, financial position and compliance issues.
In the long term, 24seven is aiming to be multi-national and multi-utility. It sees its main markets as those that have implemented, or are currently implementing, deregulation of utility industries. Particular targets are the UK, western Europe and North America.
The 24seven business model has been well received by the industry. Although it originally envisaged a doubling of its turnover within three years, the company now believes that it will be able to increase turnover tenfold in five years.
According to Harpley, 24seven has around 20 business development projects underway. Five of these are “serious” and the company is in advanced negotiations with another two. It hopes that it will seal its next contract within 12 months.
In the UK, 24seven could quickly saturate the market for its services due to regulatory and competition authority constraints. If it took on a new client in the UK power market, it has enough capacity at its Ipswich control centre to operate another network from there, avoiding the need for additional investment.
Capturing new clients overseas would obviously mean investment in new control and asset management systems, and this is a risk given that 24seven will be operating under short-term contracts. But it is a risk that the company says is manageable: it believes that if it performs as it promises, customers will renew contracts rather than pass the contract over to a competitor. “We are going to invest in our systems in order to build our business, and all businesses that invest for growth are taking a risk,” said Harpley.
24seven estimates that there is a £150 billion market out there in electricity, water and gas in its main target markets for it to capture. This is effectively a market that it has created for itself: as yet it has no competitors, although some utility companies are thought to be considering replicating the 24seven model. “We have to grow for that reason,” says Harpley, adding, “we would actually like some competition … it will prove to the regulators that this is a true market, and it will add a stimulus to what we have already changed in our company.”
While 24seven now has a nine-month head start on potential competitors, it remains keen to build up a brand both in the UK and in its target markets. Branding, believes the company, will help it communicate its values and aims to prospective companies.