Privatization lowers profits, pushes Eastern to diversify

Privatization of the UK`s electricity system is driving down prices through competition, and also creating leaner, meaner power companies as the 12 regional electricity companies (REC) vie for customers in the free market.

The industry was privatized in 1990 to expose the companies to market forces and demands. Prior to that, the system was wholly government owned.

“The 12 RECs in England and Wales were floated (public offering) as separate entities controlling the distribution networks in geographical areas of the United Kingdom but had overall control of the National Grid, which was floated as a holding company,” said John Hope of Eastern Group, at the DA/DSM(TM) show in San Jose, Calif., USA.

Aims of the industry restructuring were dual–to expose companies to competition and to purify the industry. Competition would be achieved through customer freedom of choice which would push prices down and encourage innovation amongst the utilities to improve customer service. Purification would be achieved by exposing utilities to the business environment and reducing the role of government, which would fully expose companies to the customers.

It`s survival of the fittest in the finite UK electricity market, and Hope said his company is evolving into a stronger, leaner, customer-driven machine. Staff at Eastern has been reduced from 9,983 at deregulation to 6,550 at the end of fiscal year 1994. Revenue and profits are on the rise.

Anticipating demand

“The company had to evolve a purchasing system which accurately predicted usage patterns of customers, so that maximum demand over half hour periods could be accurately estimated and contracts placed with generators. The pool (National Grid) ensured the needs of customers were supplied,” Hope said.

The National Grid orders the next day`s power from generators according to predicted demand, calculated by “a very complex, highly computerized system.” Generators face penalties for breaking Grid agreements.

Competition

By 1998 all customers will have the right to select their electricity supplier, regardless of geographical location. Already, all customers with 100 kW or larger loads can choose their suppliers. In 1990 customers with a load exceeding 1 MW were given the power to choose their supplier. This was broadened to the 100 kW level in 1994.

“Competition is true competition, not only between the RECs but with the generator companies. In fact energy brokers could also be included,” Hope said. “Up to 1990 we had evolved a very strong marketing force on the basis that service was as important as price to secure customers. This necessitated a large sales force covering all markets. It was soon established that the product was more price sensitive than believed, leading to a complete review of the sales division.”

Hope said his firm has had success obtaining contracts in the 1-MW and 100-kW markets, although these markets are very aggressive.

“We now have national agreements throughout the United Kingdom, such as McDonalds, Windsor Castle/Houses of Parliament and other prestigious buildings,” he said. Contracts run for varying lengths of time depending on circumstances and need.

Distribution

The main drive at Eastern has been to reduce costs by working smarter, more efficiently and with greater customer service. The number of employees has been reduced by 25 percent to 30 percent, but senior management has been decreased by 50 percent as the company attempts to “flatten” the hierarchical pyramid.

“As the organization is honed and focused, … new procedures need to be explored in the drive for efficiency,” Hope said. “Complete new systems of work have been introduced, breaking down outdated concepts.”

In a move to improve customer service, eight local office switchboards were closed, and two central bureaus created.

Engineering has also changed. Until October 1994, the engineering organization was split into three separate regions, each working to maximize efficiency in its region. Over the past 18 months, staff members and consultants have investigated the organization and compared it to customer needs.

“The result is a complete change from tradition and the evolvement of company-wide activities, specifically geared to customer needs,” he said. The ongoing changes in the engineering structure of the firm are expected to reduce the staff by another 450 people in the next two years, 60 percent of those coming from the professional levels.

The regulator

The electricity companies are now sensitive to commercial pressures, but the government regulator sets prices. Price increases for the RECs depend on their financial situation. Eastern had one of the lowest price allowances in the country. “To maintain shareholder confidence,” Hope said, “the profits had to be found from the internal costs of the company by more efficient working. This is one of the prime reasons why the numbers have been reduced.”

In 1994, the regulator conducted a distribution price review for all 12 RECs, taking into account current market pressures and customer needs. These reviews changed the philosophy all RECs had been following during the initial four rears of the free market, Hope said. “Up to then there was a direct correlation between profits and units sold. In fact, the more units sold the higher the profits,” he said.

The regulator changed the emphasis to cut customer waste and encourage more efficient energy use. Approval of charges to cover advertising and other marketing tools was “severely curtailed.”

An across-the-board cut of 11 percent took effect April 1, 1995, and during the next four years the RECs will be allowed to increase charges at a rate of inflation minus 2 percent.

Other changes will include:

– allowance for independent contractors to install electrical systems in new housing, blurring ownership lines for these assets,

– new quality of supply measures,

– new methods of measuring REC system losses and energy savings, and

– new standards of customer service, with financial penalties for noncompliance.

Portfolio

Increasing regulatory controls are restricting the profitability of the electric utilities, and Eastern is looking to diversification from its core business to provide profit growth in the coming years (Figure 1). Ventures include a gas firm selling to more than 6,000 customers; purchase of gas fields in the North Sea; a separate generation company developing environmentally beneficial stations to burn chicken litter, straw and other refuse items; and a separate division to perform contracting work for other RECs.

“We already have one of the lowest overall charges in the United Kingdom and are one of the top 100 companies in the Financial Times Index,” Hope said. “The next two years will be challenging as other companies vie for business, and it is unlikely that the number of RECs in the United Kingdom today will be there tomorrow.”