As Nigel Hawkings, senior analyst, utilities, at Williams de Broe points out, the sector provides a rich test of a board’s mettle. It has many challenges, from a heavily regulated environment to processes that long ago were pared to the bone. It has a user base that has almost no incentive to switch suppliers other than for a good deal – and no company wants promiscuous punters since they generate overheads without producing profits.
Moreover, the sector as a whole faces very high costs for new customer acquisition, whether by organic growth or through the outright purchase of rival businesses. Indeed, buying rivals in the UK or in Europe is becoming ever more difficult as the multiples being offered by potential buyers go stratospheric. The US has appeared to offer a more tempting arena, but there remain questions about the future attitude of the US regulatory regime to key issues such as margins and consumer protection. Finally, brand stretching into e-commerce has recently become much less attractive, for obvious reasons.
Despite this, the sector is alive with management activity – and it may yet be an area in which answers are found to some of the key strategic questions of the next decade.
Perhaps the biggest lesson right now has to do with the advantages of breaking up vertically integrated, end-to-end organisations. Elliott Mannis, finance director of AWG (formerly Anglian Water), is quite explicit about his company’s mission to transform itself. The name change, in which the water heritage and even the region have to be prised out of those deliberately anonymous initials, is one symbol of what is going on.
AWG is busy reconstituting itself as a services provider to the utilities sector in the first instance, and then to the industrialised world in general. This non-core side of the business has grown from nothing to provide 30% of revenue in just a couple of years. Mannis and the rest of the board intend to make it the core business as fast as possible.
“What we see when we look around this sector is value chains fracturing. Utilities used to be homogeneous groups that all did the same sorts of things. They all did retail, service delivery, distribution and everything at the wholesale end as well. That model no longer works for us. You have to decide where you want to play and you have to be world class at what you do,” he says.
For AWG, this means focusing on infrastructure and asset management.
The acquisition of the Morrison Group gave AWG significant additional assets in this area, as well as expanding its infrastructure construction and development capabilities. The company already manages significant chunks of Transco’s distribution assets in the South of England. It provides technical and support services to three quarters of the local councils in England and Wales and it is actively looking to export those skills abroad.
“The trend towards fracturing the value chain you see in the utility sector you will see over the next few years in the public sector and other areas. The vertically integrated organisation has had its day,” Mannis says.
AWG has already experimented a little with e-commerce and brand stretching, with a vehicle called Anglian Water Direct, but according to Mannis, the company will not be charging into the e-space. It does, however, plan to leverage e-procurement. “There are always new opportunities and ideas, smarter ways of doing things. We put a new billing system in place this year that is scalable and flexible, and this is the next logical step in our development,” he says.
Paul Marsh, finance director of TXU Europe, agrees that focus is important.
When TXU added Norweb to its portfolio recently, it struck a deal with Vertex to outsource the servicing of the whole of Norweb’s infrastructure.
On top of this it added Eastern’s infrastructure to the deal, considerably expanding Vertex’s portfolio in the process. “Vertex is setting out to be a world class infrastructure management company, and we are happy to leave this to them. We intend focusing on the things we’re best at,” he says.
What TXU is rather good at right now is adding scale. The acquisition of Norweb gave it an additional two million customers and turned it into a five million customer player. According to Marsh, there is a surfeit of two million customer players in the market, and at that level it is hard to stay viable. But he warns that companies that look to expand at any price are heading for trouble.
“No one in this sector has yet discovered the Holy Grail, by which I mean the ability to grow customer base significantly, without paying too high a price,” he says. The Norweb acquisition cost around #250 per customer – but there is the additional cost of transferring the new customers onto the acquiring company’s systems to be considered. Since the point of acquisition in this sector tends to be to grow the client base, there is little point in soldiering on with isolated billing systems. The point of having a large client base is to be able to address that base coherently, which means still more costs.
A better route to increasing profitability than outright acquisition, Marsh suggests, is to buy positions in European operations as they become available. He points out that a significant element of TXU Europe’s profit growth currently comes from its German and Nordic ventures (Germany and the Nordic countries have been the quickest to deregulate on mainland Europe, with France being the slowest). The key in Europe is to acquire deep local knowledge by working with influential local players. By leaving its partners with a stake in the game, TXU lays the basis for a long term, fruitful co-operative venture where it learns as it goes. “The key in Europe is not to charge in with an Anglo Saxon view of the world. You have to work with partners who understand the landscape,” he says.
While TXU has had to walk away from several opportunities recently because of the volume of what Marsh calls “dumb money” washing into the sector and over-valuing assets, he is happy to see new entrants coming into the European arena. “The more new players that come in the better. They introduce volatility and uncertainty to the market and make it much easier for us to apply our risk management techniques. We are happy to stand or fall by our creativity,” he says.
Nick Fisk, supply finance director at Yorkshire Electricity Group reckons that his company will shortly have a marketing job on its hands establishing its new brand identity. In line with the regulatory requirements, Yorkshire is having to turn its supply and distribution divisions into separate companies.
“We’ve been looking at what the future looks like for the supply side, and at what has been going on in the sector for the past 18 months. People are coming up with all sorts of ideas and propositions for their existing and future customers,” he says. What is clear is that the value in the industry has shifted quite markedly out of generation and distribution and into supply, which, of course is no bad thing for his operation. “We’ve seen the multiples per customer go up by at least #50 over the last year. And we’ve seen people looking at how they can generate more ‘stickiness’ in the customer base and grab a larger share of the customer’s wallet.”
At the top of the list of the company’s plans in this direction is the formation of alliances with companies who can meaningfully cross refer customers. “We’ve looked at the casino costs involved in a pure marketing spend approach to making your web site visible. That is a steep price to pay for e-initiatives, particularly if the returns are thin in the early years. No one company can carry the burden of creating visibility alone, so alliances here are a great way forward,” he says.
Everyone in the sector acknowledges that when it comes to brand stretching, Centrica leads the way. However, as a Centrica spokesperson says, even the market leader can only claim to sell 1.8 products per customer. Centrica plans to extend this to about 2.3 or 2.5 products per customer by 2003 to 2005, which is hardly a dramatic increase.
Centrica’s model also tends to raise more questions about branding than it provides answers at present. Although it has received some dramatic coverage for its out of sector acquisition of the AA and its Goldfish business, it continues to run these as separately branded businesses.
The rationale is obvious, since the AA is a famous brand, but as Paul Marsh notes, it leaves one wondering how much synergy there is between the concepts.
While everyone dabbles at e-business and brand stretching the real game continues to be about scale. Companies in the sector may not yet be clear about what they’ll do with the customers when they get them, but they know in their bones that they need as many as they can get. Centrica’s fundamental vision, the spokesperson said, was on expanding in Europe and North America. It plans to have a North American customer base of 10 million by 2003 and a European base of five million customers within five years. The company also plans to have a million UK customers for its new telco service by the end of this year.
“When the market opened up in 1996, the only sure thing we had in front of us was that we had 19 million customers in the UK and we were going to lose some. We think our response has been pretty good,” he says.
Chris Greenwood, utilities consultant at Cap Gemini Ernst & Young argues that overall, despite a tough regulatory review over the last 12 to 18 months, the sector is now in pretty good shape. “The biggest challenge ahead for the electricity sector is the new trading arrangements that come into force in March. The move to a contracts based system is going to test their acumen,” he says.
KPMG partner John Smith notes that – natural disasters aside – utilities enjoy a particularly trusted relationship with the consumer. They have yet to discover the right way of leveraging that into anything eye catching in the cross-selling line, but it is still early days in the e-game. He believes that the key lies in bolder thinking. “The value of a utility driving into some kind of exchange based facility would be huge. If a major utility got together with a world class car manufacturer and a leading airline, plus say a Dixons and a Sainsbury, their combined buying power would be enormous,” he speculates.
Getting customers and scale through acquisitions without really knowing how to leverage those customers may turn out to be putting the cart before the horse. But the utility that stumbles onto the right way of leveraging its existing brand in the e-space may just find that customers come running when you have something to offer them.