The Need for Reinvention: Are UK Utilities Prepared for Change?
As the energy landscape shifts towards renewable energy, energy efficiency and distributed generation, large utility companies are under increasing pressure to provide services other than kilowatt hours and therms of gas.One important question as such is how well equipped these companies are to change their business models towards less carbon intensive and more service related value propositions.Some argue that this shift is an absolute necessity if traditional utility companies want to survive in the long-term. The logic is as follows: utilities generate profits by selling electricity and gas from centralized power stations. Energy efficiency and distributed generation reduces demand thereby shrinking profits and leaving those customers still left paying higher prices to cover the fixed costs of the by now struggling utilities. This leaves an energy system dominated by renewable and distributed technology in which communities have the means to generate their own power. To some extent this is already the case in Germany where nearly half of installed capacity is distributed. Furthermore, utilities could benefit from offering services that compliment this development as their generation fleets become less valuable.
But can this scenario be said to be an imminent threat to incumbent UK utilities?Probably not.Industry, and especially the vertically integrated players, argues that there will be plenty of work to go around even in a world where distributed generation and energy efficiency reduce a sizeable portion of total electricity demand.Networks need to be maintained and someone needs to be there to flex gas generators up and down – costs will need to be covered and profits made for those who take that on.
However, the scale and urgency of the energy transition is hard to predict and previous logics and assumptions are likely to fall short.The logic of the current utility industry is based on the belief (yes, belief) that the energy system as a whole is immune to the same processes that have disrupted and turned other industries on their heads such as telecoms, IT, the disk drive industry, music recording and distribution and so on. These industries were disrupted by the introduction of better and more modular technologies that incumbent companies did not or would not see coming – some argue, in the same way that large utilities treat distributed generation and energy efficiency now. The fundamental question to ask is therefore: to what degree is the energy sector immune from the disruptive processes seen in other industries?
On one hand, the volume of investments and long-term nature of energy infrastructure points towards there being a degree of inherent protection for incumbent utilities that is not prevalent in more high-tech and fast paced industries.Moreover, 96 per cent of UK customers get their electricity from the Big Six that also control well over 60 per cent of the wholesale market.The UK utility industry could therefore be ‘too big to fail’.On the other hand, market developments towards decarbonisation, guided by increasingly frequent political intervention (the web of complex policy interactions in the Electricity Market Reform being the latest), have no patience for slow movers and the energy markets are, in one shape or another, becoming more dynamic and unruly.The industry is therefore entering unchartered territory and the survivors are likely to be those who have the tools to navigate and take proper strategic precautions.
As the traditional utility business model has historically generated stable returns the industry has had little incentive to reinvent itself and find new ways of generating revenue.Such a ‘reinvention’, or strategic shift, would entail incorporating into managerial decision making what the academic literature refers to as ‘dynamic business models’ capable of dealing with ‘paradoxical strategic choices’.Simply put, this means that a company has the ability to successfully search for new business models while exploiting existing assets to maintain a revenue stream.For the utility industry this means having the ability to maintain and operate their centralized generation fleets (investing in, say, higher efficiency and flexible gas turbines) while allocating sufficient resources to successfully explore distributed generation and energy services models.Exhibiting this dual ability has long been recognized to be a prerequisite for maintaining long-term competitive advantage in dynamic market environments.
There is little sign of this reinvention currently happening in the UK utility industry, however.The industry sees little or no threat from distributed generation and energy service business models.Strategic choices therefore continue to focus on load factors and economies of scale and are, as such, single minded in their predisposition towards the continued sales of kilowatt hours.The volumes of investment and strategic coherence needed around developing new business models are still overlooked and both the market for distributed generation and energy services continue to be dominated by smaller, more local and specialised firms.
While sticking to what one knows can be useful in the short term it also carries the downside risk of being left behind as the electricity markets gear up for significant change.Reinventing ones business model and organizational capabilities to deal with uncertainty should therefore be considered a rational way of navigating this new turf.
– Paul Robson (Twitter: @paalrob) – previous MSc Energy Policy student with the University of Exeter