By Siàƒ¢n Green
Cashing in: there are tangible rewards for innovation, says PwC’s Keenan
Players in the energy industry around the world are facing pressures from all sides in the competitive environment. But how can they deal with this and get ahead of their competitors? The answer is simple, says PricewaterhouseCoopers: innovate.
Energy companies operating in deregulated markets have found many ways to deal with competitive pressures and make their squeezed margins count: cost control; consolidation; growing customer base; and risk management, to name a few. But securing a path to growth and a strong future is a whole new ball game.
The key to success could lie in an ability to be innovative – to breed new ideas and bring them to market quickly. Rather than just looking after existing products and revenues, market players need to find new ones.
A recent survey by consultants PricewaterhouseCoopers (PwC), designed to assess how today’s leading businesses are aligning themselves for the challenges of tomorrow, made an interesting finding: out of 26 industry sectors surveyed, energy and utility companies ranked second for innovative ability. Second only to the technology sector, the energy industry ranked above entertainment and media, retail, consumer goods, and financial services.
PwC found that typical energy companies generate 50 per cent of their revenues from new products, well above the all-industry average of 38 per cent. They also display a strong ability to generate revenue from new products, suggesting that they experience great success with new product launches.
The clear driver of innovation in the energy industry is, says Gerry Keenan, leader of PwC’s Energy/Utilities Strategy Consulting Practice in North America, market liberalization. Companies must find new ways to differentiate themselves from their competitors and adapt to market changes.
Prior to deregulation of energy markets in the USA and Europe, innovation came in the form of technical developments from the engineering side of the business. These focussed on making products more efficient from an engineering point of view, rather than from an economic point of view. But under competitive market conditions, both these factors become important. “This is because there is a tangible reward for innovation,” said Keenan. “While everyone has an interest in innovation, [it] becomes a real priority when you suddenly have to scramble for customers, rather than being able to take them for granted.”
Innovative concepts that have been brought to market in the last few years include different billing and service options, financial products for hedging risk, as well as new, niche technologies such as fuel cells. The Internet has, of course, played a major part, and will continue to do so.
Wholesale slowness: companies in the UK retail sector have shown strong innovative ability, but the wholesale market is lagging behind
PwC’s survey found a marked difference between the US and the UK in terms of innovation, which correlates with how deregulation has been implemented in these two countries.
According to Keenan, there is a great deal more innovation in the UK market than in the US, especially in the retail sector, which in the UK is contestable. “When you look at the retail side of the electricity markets, the UK is well ahead,” said Keenan. “Companies like Centrica are good examples in the way that they have expanded their business from simply being a gas supply business to having something like three million electricity customers. Both from a corporate point of view and [in] thinking about what customers will buy and what bundles will be attractive, I think they’re certainly ahead of most firms in the USA.”
Another notable UK company that has shown innovative drive is Scottish Power, which has evolved from an electric utility to having operations and strong brands in water, gas and the Internet, and it recently signed a joint venture deal with the Royal Bank of Scotland that will give it increased customer capture opportunities.
On the wholesale side of the market in the UK, the story is different. Although deregulated, a lack of fluidity has negated the demand for new products and services. “Having a pool structure really didn’t provide for much innovation,” commented Keenan. This is in contrast to the USA, where in the fully deregulated gas and electricity wholesale markets, a range of physical and financial products have been developed to serve players who need to hedge against risks.
These products have been used quite aggressively in the US by buyers in the wholesale markets whose supply businesses are regulated. As they cannot pass price fluctuations on to their customers, they have used a variety of products to manage this risk. Weather derivatives have been particularly effective. “The one [product] that has been most innovative is the weather derivative. They were pioneered a couple of years ago … but now there are eight or nine trading operations that make a market in [them].”
Such products are also likely to emerge in the UK market once the new trading arrangements (NETA) have started. Even though NETA will consist of largely a bilateral market, independent power exchanges will help to provide fluidity. The range of products available will also increase as the gas markets are liberalized, says Keenan. “That volatility will then flow through to generators and traders, and also to companies in the supply business.”
The Internet is also driving innovation in the energy business. Keenan believes that the Internet has become absolutely essential for successful innovation, and although there will be innovations that are not reliant on the Internet, those that will have the most impact are likely to leverage its power.
The Internet revolution has seen many start-up companies. The majority of these sell utilities over the Internet to business and retail customers, or offer procurement services or trading platforms. The survival of these dot coms is debatable, however. “The truth is that most of these don’t have any customers,” said Keenan, adding, “so it is wonderful to be innovative, but if you don’t make any money, you won’t be innovative for long.”
This comment brings home the fact that there is a certain amount of risk involved in being innovative, and although smaller companies are probably better at being innovative than large ones, they cannot afford to make as many mistakes. Innovation requires focus, flexibility, and in most cases, a shift in culture.
Motivation: companies must encourage and reward innovation, but be ready to call it quits
To innovate, companies have to change the whole way that they think about their business. They should reward innovation, provide ways of developing ideas, and, says Keenan, they have to think about the cycle of innovation in terms of weeks and months, rather than years.
Royal Dutch/Shell and AES Corporation are two companies that exemplify innovation encouragement, according to PwC. With its ‘GameChanger’ process, Royal Dutch/Shell has seen over 320 venture ideas submitted in three years by its employees. AES has established itself based on decentralized organizational principles that minimize the number of management layers and increase the level of responsibility for each employee. This gives employees the freedom to be entrepreneurial and creative.
Important lessons can be learned from the consumer products and services market, according to Keenan. For every 100 good ideas, around ten become marketable products, and of these, maybe two or three are still around in five years’ time. “There is a high failure rate, and one of the things that you have to get accustomed to, is that not every good idea and not every good product will be accepted by the market or be commercially pleasing to the target audience,” said Keenan.
Utilities in particular can have problems recognising this, and can be slow to cut their losses if a particular product is not working. “So one of the things that is required is not only the ability to develop innovative ideas and products and the skills to bring them to market, but [an] attitude that can say: ‘Okay, this was a nice idea but its not working, so let’s kill it’.”
Because of this, it can help to have people on board who have had exposure to consumer or financial markets. Their experience can help reduce the risks associated with innovation and bringing new products to market.