The way in which utilities approach asset management is changing in response to the emergence of liberalized and competitive markets. Capgemini argues that this will require utilities to shift from engineering to an integrated business focus in order to achieve the right balance.
Regnerus Coops and Peter Witberg, Capgemini, UK
The international utility sector has changed beyond recognition over the past decade. In the UK in particular, the unbundling of supply and distribution in electricity and gas has led to a natural review of core competencies including how assets should be owned and managed. This separation has led to a period of second-wave unbundling whereby asset businesses set about disaggregating their operations at a deeper level with the intention of optimizing performance.
In doing this, organizations have considered more radical options around business change. The last few years have seen a step change in focus around utility asset management across the globe. Major players in Western Europe and North America have set about redefining their asset management operating models and are seeking to gain competitive edge by optimizing component parts of this model.
As the principles of asset management have become more refined, the logic behind second-wave unbundling for asset-centric businesses has been generally accepted. The over-riding goal for incumbents is to optimise the balance of risk, cost and performance around the management of a complex and distributed asset base.
Before considering the different business models that an alternative approach to asset management makes possible, it is worth looking at how the basic management of assets such as networks has changed in recent years.
In the past, state-owned utilities viewed assets purely as the infrastructure by which they supplied services to customers. Asset management was to do with maintaining service delivery to an acceptable level. Changes in the business and regulatory environment led to a new emphasis to reduce capital expenditure. There is much more focus on financial rigour and integrity, while regulatory issues have introduced further pressure to address customer service and financial management issues.
Shareholders are also looking for higher rates of return, while monitoring the quality and integrity of service delivery and levels of investment in infrastructure and technology.
Figure 1. Effective asset management: the ability to understand and manage the right balance between risk, cost, and performance
As a result of all those changes, the objective of asset management today is accepted to be about much more than maintaining an asset in an operational state, or managing resources to carry out work on an asset. It should also be about more than investing capital in an asset simply to ensure that budget allocations are spent, or operating an asset in a particular way because it has always been done like that.
One way of looking at assets is that they are essentially the balance sheet reflection of past investment decisions. Once investment decisions are made, the business not only has to sweat these assets but also maintain them and decide when to reinvest or divest.
Along the way the company has to manage a host of business, operational, legal, tax, regulatory, security, safety, health and environmental risks associated with owning and operating its assets. Executing this task, which involves complex trade-offs and decision-making, is highly information dependent and hence technology is a key enabler of risk-based asset management.
Capgemini therefore believes that the basic objective of asset management for utilities today is to create value from owning and operating an asset base, and to understand and manage the right balance between risk, cost and performance. There are two key approaches to asset management: the engineering excellence profile and the fix and fail profile.
The first profile is built on the principle that high operational performance can be achieved with low risk of failure. This also involves higher levels of financial investment, because it is the only way to guarantee excellent performance. The second profile can achieve higher financial performance, but with high levels of risk and potentially poor performance.
We believe that there is a third ‘risk-based’ option. Developed by Capgemini over the past decade in collaboration with customers in the utilities industry, risk-based asset management is the process of managing a large asset base and dealing with the risks that are inherent in this process.
This means that the key to effective risk-based asset management is having a decision making process based upon the risks associated with the actual performance of the assets. There are three key steps: understanding the profile that is required; understanding the profile as it is now; and understanding how to bridge any gaps.
As such, best practice asset management is about linking strategy and values to key processes across the asset lifecycle – the core value lies in decision-making at a strategic level.
The questions that companies need to consider at this stage include:
- How do we deal with the increasing demands and expectations of stakeholders?
- How do we manage all business risks associated with owning and operating an asset base in a responsible, comprehensive and affordable way?
- How do we create a complete and defendable financial transparency across the asset base, linking proposed investments to expected risk profiles and performance?
- How can we create a balance in the organization between an economic assessment of what the business can afford to do and an engineering assessment of what assets need to keep up their performance?
- How to integrate safety, health and environmental considerations in a pragmatic, comprehensive asset management model?
Achieving and sustaining the vision that is defined as a result of that process is only made possible by placing a real focus on a clear definition of roles and responsibilities within asset-centric businesses. This is implemented through a further wave of unbundling, which separates the three distinct units of asset management in their broadest sense: asset owner, asset manager and service provider.
Each of these business units is a viable undertaking in its own right, and unbundling decision-making (owned by the asset manager) from actions (owned by the service provider) enables each to focus on its core competencies without having to work in a constant state of compromise.
Industry players have consequently refocused around core competencies in pursuit of industry-leading performance at each of these three levels. Previously these functions were merged within organizations – unbundling allows each to achieve effective delivery by concentrating on core skills and outsourcing those activities that are seen as non-core to the business.
Figure 2. To maximise value, significant changes in focus are required
For the asset owner, the focus on financial efficiency and regulatory liaison aims to reduce risk exposure and thereby cut the actual cost of capital to a level below that stipulated by the regulator. Whilst this holds an obvious benefit for the asset owner itself, it merely transfers risk to one of the other parties – namely the asset manager and/or service provider.
In the case of the asset manager, the benefits accrue from the ability to balance capital and operating expenditure in a co-ordinated manner – ensuring that strategies and policies are aligned in support of the business values of the asset owner and that work packages and commitments are passed to the service provider that is best placed to deliver them.
The balance of spend and consolidation of service providers means that spend profiles can be optimized for the medium-term and the ‘loose expenditure’ so common within highly decentralized models (e.g. multiple service providers, non-standard equipment and fittings) would be avoided.
Finally, the service providers themselves benefit because they can concentrate on the core competency of scheduling manpower and delivering high quality services at market rates. This forces market players to operate at maximum efficiency and gives those that succeed future options for expansion in their specialized areas within a market that is fast becoming commoditized and highly competitive.
By disaggregating the key elements of the asset management operating model, an asset-centric company can reap the benefits of competitive market performance at each of the various levels.
Shift of focus
But to really maximise value from asset management, companies need to make a significant change from an engineering focus to an integrated business focus.
To achieve a change in focus from being engineering-led to an integrated business focus, businesses need to transform the way their company is organized and managed.
There are a number of challenges that companies need to be aware of when they are in the transformation phase. The first is that they are likely to face resistance from the business when the three roles of asset owner, asset manager and service provider are made explicitly separate. In most organizations they are already separate but implicitly so – unbundling can create uncertainty over areas of authority and control.
A second challenge is that asset data needs to be collected in a more detailed and accurate fashion. Asset data is the lifeblood for an asset manager, but very often risk management and analysis tools are lacking, while there can also be a huge debate over who owns the asset-related data within the company.
It is also important to recognise that the SAP-based infrastructure used by most utilities will support some – but not all – of the processes run by asset owners and managers. Finally, organizations need to ensure that they have the right competencies to run their business according to a risk-based model. They will need to focus on non-technical competencies relating to running processes at asset owner and asset manager level.
One example of a company that has already benefited from a change in approach is Essent Networks, which is the largest energy distribution company in the Netherlands. Following deregulation of the Dutch electricity sector and a reduction in income forced by a more competitive marketplace, ENN Essent Networks undertook a review of its decision-making process regarding capital and operational expenditure.
Essent’s heritage culture was one of engineering excellence, so that traditionally any problems had been resolved with a ‘Rolls Royce’ solution, regardless of resources needed or costs involved. It began asking questions such as ‘can we do it at a lower cost?’ and ‘can we do it next year?’. But it still wasn’t asking the question ‘what will happen if we don’t do this project?’
Working with Capgemini, Essent introduced a new approach, starting from an understanding of top level business risks associated with shareholder value, safety, reliability, compliance, environmental safety, regulatory compliance and brand image. Top management identified risk tolerability for all of those values against four classifications: high, medium, low and negligible.
Essent then started searching for points in its distribution network where risks could occur – the bottlenecks. The difference between this approach and the traditional approach to asset management is that Essent could now proactively search for bottlenecks with the highest associated risk and monitor them as part of a risk register, instead of waiting for problems to occur then fixing them.
Following this change in approach, Essent’s management could set total budgets for asset management by evaluating expected performance against performance targets, and the budget is divided between the programmes using the same marginal yield for all programmes.
The experience of Essent Networks is a good example of the benefits of the risk-based approach. Essent became the first company in the Netherlands to fully control its maintenance and capital expenditure by means of a reversed risk management process.
It is important to stress that while implementing best in class asset management can bring huge financial benefits, this is not about cost reduction. Instead, it gives companies an understanding of risk exposure against business values and from there they can identify areas for improvement.
With utility sector players across the world reconsidering which of their competencies are core to their business, it’s not surprising that unbundling is giving rise to new and competitive markets around asset management services, as well as attracting new entrants from outside the sector.
Capgemini believes that this move will also lead to a level of transparency never previously experienced in the sector. For many organizations, the idea of the virtual utility through wide-scale outsourcing of activities previously viewed as core business is becoming a serious option.
In a wider context the acceptance of more radical securitization and mutualization propositions has resulted in significant interest in the utilities sector from potential new entrants, particularly those in the financial sector.
Figure 3. Distinct responsibilities for translating the stakeholders’ demands into asset related activities
Such an approach has been particularly evident in the US, with the securitization of assets becoming a key tool to help recover stranded asset costs, as occurred with PECO Corporation. For financial players, the idea of balancing a portfolio of investments with a fairly low-risk return in excess of five per cent from a regulated utility has a number of attractions.
Asset management services
Two key drivers within the industry are leading to growth opportunities for asset managers, which were never previously in existence:
- Adoption of the best practice asset management operating model
- Drive to optimize each level of the business.
There have been many estimates around the value of the asset management services market, but whilst the range of assessments vary widely at levels above $119 billion it is a big and relatively immature marketplace.
The provision of contracting services is clearly nothing new and there is already a fairly mature contracting market in existence in many countries.
The next challenge will be how to break into higher value asset management market with a differentiated proposition, focusing on decision-making rather than the action component. This will result in the emergence of three different types of client service: consulting, mentoring and managing.
Consulting to asset-centric businesses already exists and will continue to exist, but with a different focus. Alongside the existing niche engineering consultants will reside expert practitioners who are actually running assets using best practice methodologies. No longer will these units be arm’s length divisions within a wider corporate body but will instead become part of the fundamental operating model.
At the next level, the mentoring offering will seek to transfer the capabilities of a best practice asset manager and any partners to a client over a period of time (two to five years). The goal is to carry out the necessary transformation of people, processes and technology to leave the client with a viable long-term business operating within a best practice environment.
This model has a number of advantages for both parties. For the client, it provides the opportunity to retain control on an ongoing basis should the strategy be to enhance and retain capability in-house. For the mentor it provides all the growth benefits of long-term engagements without the need to set up a new venture or absorb staff into the existing business.
The final level is the holy grail for any asset manager looking to grow their business without acquisition. This is to manage another organization’s asset base and could entail a choice between two propositions – the specialist asset manager and the self-managed service provider.
Although the UK and the US utility markets appear to be accelerating towards this new model, the wider picture still appears fairly confused. The contracting companies seem to be attempting to move upwards in the asset management value chain, but it is no easy task to begin offering higher value asset management services as well as high quality service provision.
From the other side, utility companies with their strong engineering expertise are offering contract service solutions. Again, this has proved to be a difficult step to take.
The implications for the industry seem clear enough – an international market for asset management. Those players who see a future in asset management must consider their core competencies today in order to be prepared for tomorrow. As such the evolution of new market models will bring both threats and opportunities.