IBM Business Consulting Services

Futures Series

Bigger, Smarter, FasterTransforming Utilities into Global PowerhousesVision of the Energy & Utilities Industry, Circa 2007

table of contents

This paper is part of IBM Business Consulting Services on-going

commitment to forward-looking industry and business points of view,

and our aim to help companies and industries Transform Futures.

Forward: Bigger, Smarter, Faster

Transforming Utilities inGlobal Powerhouses

Drivers of Change

Making the Portfolio Dynamic

Conclusion: Delivering Long-Term Value

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Bigger, Smarter, Faster

Transforming utilities into global powerhousesVision of the Energy & Utilities Industry, Circa 2007

1

JulJulJulJulJuly 1y 1y 1y 1y 1, 200, 200, 200, 200, 20077777: : : : : John Scape, treasurer of Regional

Energy Inc., runs his hand through his hair. His nerves

are already frazzled and he hasn’t even faced the

board enquiry yet.

“John, you OK?” He looks up to see the company’s

CEO Kim Brookes standing by the office building’s

unmarked side entrance. She appears haggard after

the morning’s meeting.

“Yeah, I’m fine. How are you holding up?”

“I’m hanging in there. But I needed some air before

facing that group again. It’s more like a firing squad

than a strategic review.”

John chuckles. They are silent for a few moments.

Finally he asks, “Did you see this thing coming?”

“Sure,” she answers. “Five years ago.”

John stares blankly. “Five years ago? How come?”

Kim sets down her briefcase. “I told the board five

years ago that the industry’s structure was changing,

and the capital markets would expect us to change

accordingly,” she says. “But they didn’t like what that

meant. None of us did.”

John says, “I can see why. It meant our whole business

plan was obsolete.”

She nods. “It meant more than that – it meant we

were becoming obsolete. Our portfolio was losing

value and our risks were rising. The writing was on

the wall, but nobody wanted to see it.”

John’s brow furrows. “But that’s understandable, isn’t

it? Lots of companies were having trouble back then.

Practically everyone’s stock was slipping, and

everyone faced greater risks.”

“That’s right”, says Kim, “but some companies actually

did something about it. Did you see the profile of

Energy Global PowerHouse in Fortune Magazine last

month?”

“Sure” says John, “who didn’t? But what does that

have to do with us?”

“Well, five years ago, our companies looked the same.

We thought of them as an equal. Seems almost

unbelievable now.”

She goes on to talk about how Energy Global

PowerHouse (EGP) is at the top of the charts for

shareholder returns. How it competes on a global

basis in almost all areas of the value chain –

production through retail. EGP, she says, has a

portfolio of physical and knowledge-based assets that

allows it to compete effectively in the changing

market.

“While we were tinkering with our business model

EGP moved to a dynamic portfolio approach,” she

remarks. “Its merchant energy business comprises a

balanced set of assets, both from a fuel and market

perspective. The company manages these assets

through robust, risk-based trading operations –

hedging its exposures. At the same time, the

company still plays to its traditional strengths. Its

2

strong operational roots show up in the overall focus

in running both the merchant and wires businesses.”

“OK”, says John. “But they’re major-league. We don’t

have their clout or muscle.”

“That’s right,” says Kim. “And whose fault is that? The

board at EGP saw what was coming. They saw the

importance of having a set of customers that allowed

the company to be a price maker and not a price

taker. The company operates as a truly global

business. It manages its business as a portfolio, not a

series of independent business units. The bottom line

is that those guys saw the new market realities and

acted on them.”

John shakes his head. “OK, but for us the risks came

from being a regulatory-driven company in a competi-

tive marketplace. We needed a new corporate

structure. We needed to eliminate our dead wood and

feed the live wood.”

Neither one says what they both know – that back

then Regional Energy couldn’t admit to having dead

wood. Never mind that an asset wasn’t making

money, wasn’t growing, or that it had outlived

whatever usefulness it once might have had.

Assets were assets, and you didn’t sell them unless

you had to.

Kim picks up her briefcase. “The sad thing is that we

could have been a leader in this industry. We could

have been where EGP is today. We had first-rate

operations, a good market position and great people.

But instead of doing what was necessary – and

rebuilding the company to compete for customers and

capital – we retrenched. We took the easy way out.

And I led the way.”

“We could have been a contender,” John says, doing a

bad impression of Marlon Brando in “On the Water-

front”. “You just wish it was your face on the cover of

Fortune magazine.” They both laugh. John shakes his

head again. “I think you’re being too hard on yourself.

You did what the capital markets forced you to do.

There was a flight to quality, for heaven’s sake! They

wanted quality, so you gave ’em quality.”

Kim laughs ruefully. “Then why are we here, John?

Why is our stock worth a fraction of what it was 10

years ago? Why are we losing our best talent? Why do

we get eaten alive in every new market we try to

enter?”

He feels chastised. “We’re just a local utility,” he says

sheepishly. “We never wanted to be more than that.”

“Exactly,” she says. “And that’s what killed us.”

3

Transforming Utilities intoGlobal PowerhousesBy 2007, energy and utilities companies will find themselves in a more disaggregated, multinational industry.

The demands of this new marketplace – and the increasing expectations of the capital markets – will drive

companies to transform themselves into larger, more dynamic, better-focused players.

To thrive in this new landscape, industry leaders will need to shed non-core assets and focus on competencies

that support growth. Business strategies will develop around one or more of four core business areas – merchant

energy services; transmission; distribution; and retailing. Regulatory-driven corporate structures will break down

and will be replaced with new, market-driven structures that make optimal use of assets and resources.

Companies will be challenged to reinvent themselves to meet the diverse demands of competitive and regulated

businesses in many geographic regions. Industry leaders will achieve their goals by pursuing a disciplined

portfolio-management approach – buying, selling and leveraging assets on a global scale to meet a defined set

of corporate objectives. Those that execute these strategies most effectively will emerge as global “super

majors,” dominating the industry’s most lucrative business sectors and regional markets.

To succeed in the competitive landscape of the future, energy and utilities companies must begin the transforma-

tion process now.

Powering UpIn the next five years, traditional utility companies will

have to transform themselves to compete in a fast-

moving market quite unlike anything seen before.

Today, leading energy and utility companies are already

beginning to apply portfolio management techniques to

their business activities. In the coming years that trend

will accelerate.

By 2007, there will be an explicit distinction between

energy activities (acquiring, producing and retailing

electric and gas energy) and utility activities (providing

transport services to get that energy from point of

production to point of use).

Four primary forces will transform the industry:

� Deregulation and restructuring of energy markets

� Growing demands of capital markets

� Diminishing opportunities for domestic growth

� Increasing use of outsourcing and enabling

technology.

The Power Portfolio

The concept of portfolio management is not new, but to date energy

and utilities companies have not applied it as aggressively as they

will in the future.

The basic idea is simple. A holding company – or in some cases an

individual business unit – assesses the businesses and assets it

controls in much the same way an investment fund manager

assesses a portfolio of securities and properties. This assessment will

be carried out on an ongoing basis, against rigorous performance

criteria.

Corporate decision-makers will manage the company’s business

accordingly, seeking to acquire new properties that meet the

criteria, and selling assets that cannot meet the criteria consistently

– or that can bring greater value by being liquidated.

While many energy and utilities companies are pursuing this

approach to some degree, for many it represents a significant shift

of strategy. Companies in the industry traditionally have clung to

under-performing assets long after they outlived their value to the

company’s profitability. A good portfolio manager, however, will be

ruthless about divesting property that can no longer meet expecta-

tions. Even if some assets are sold at a loss, over time such an

aggressive, dynamic approach will provide superior returns –

assuming the performance criteria are structured properly and the

strategy is executed proficiently.

4

These new drivers will cause a fundamental shift in the industry’s structure:

� Components of the traditional utility value chain will be disaggregated and then reaggregated into combina-

tions that create value for individual companies.

� The drive to secure economies of scale will accelerate consolidation across the globe and across all areas of

the value chain.

� Globalization will lead to the emergence of a handful of energy and utility “super-majors”.

� Information and the ability to use it effectively will become critical assets for driving growth and

creating value.

All of these changes will be aimed at achieving one primary goal: optimizing a portfolio of businesses and assets.

The winners in the new industry landscape will be characterized by three attributes: They will be bigger, smarter

and faster than anything the industry has seen to date. The global leaders will metamorphose from traditional

energy and utilities companies into modern multinational companies.

Some of these changes have already begun. From a structural perspective, the most dramatic sign of the utility

industry’s transformation to date has been the disintegration of incumbent, vertically integrated utilities into

functionally based business units.

The degree of unbundling that has occurred varies internationally, depending on market circumstances and

maturity. In the United Kingdom, for example, regulatory requirements have forced the separation of retailing,

distribution and metering; while in the United States the regulatory regimes largely treat them as one entity (the

state of Texas being a notable exception). In other markets, generation has only recently separated itself from

the other functions on a wholesale basis. Some markets are still working out the specifics of their unbundling

schemes although separation of transmission is widely recognized as the first prerequisite for market liberaliza-

tion.

In any case, the functional disaggregation trend is not likely to reverse itself. Current global trends in capital

markets, globalization, regulation and legislation, outsourcing and new technologies all support continued

unbundling where it makes business sense. Indeed, outsourcing the maintenance of a distribution network is

little different from outsourcing the maintenance of a car assembly plant or the facilities management of a large

office complex. But as will be discussed later, there are countervailing reasons in the utilities sector for then re-

aggregating components of the value chain.

By 20071 , old-style vertically integrated – and primarily regional – companies will give way to a new type of

organization that is more adaptable to changing market conditions.

The leading companies in this changed environment will:

� Organize their various roles into business models that optimize shareholder value within acceptable risk

boundaries

� Focus their efforts on core business areas, spinning off, outsourcing or creating joint ventures to fulfill

functions that don’t serve corporate goals (See Sidebar, “The Power Portfolio”)

Integrated Utilities

Source: Dow Jones Interactive: 9/03/02

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Highly integrated companies will remain a feature of the utilities industry, but only where there is a clear

business rationale and not just because of regulatory dictates. While regulation will still determine significant

aspects of the utilities segment, companies will manage regulated businesses to their advantage in developing

their preferred portfolios.

In this new industry structure, a limited number of integrated, global players will emerge. These companies will

be the “super majors”. They will participate in multiple segments of the energy and utilities value chain, manag-

ing their organizations as portfolios of integrated businesses to maximize global shareholder value. At the same

time, other specialized companies will pursue more horizontal strategies, focusing on core competencies in the

areas of merchant energy; long-distance transportation; local distribution; and retail services.

For all energy and utilities companies, the pursuit of economies of scale will be a strategic imperative. But for

the super majors it will be the key to their market leadership.

The advantages of scale and specialization are well understood and readily visible in most sectors. Larger

companies enjoy advantages that smaller companies do not. For example, larger companies can achieve cost

savings because they have more negotiating leverage in the market. Larger companies are generally better

positioned to pursue value opportunities, because they can spread risk among a diverse portfolio of assets and

can absorb losses that might cripple smaller companies. For the capital markets, this translates into lower risks,

and thus larger companies can obtain broader access to the capital markets.

This access will come none too soon. Today and in the future, energy and utilities companies must compete for

capital against world-class petroleum, telecoms and manufacturing companies. No utility company has yet grown

to the size of a BP Amoco or General Electric, but in order to compare favorably against such giants, energy and

utilities companies will need to significantly bulk up their balance sheets. This does not mean, however, that

companies will become more monolithic. On the contrary, as energy and utilities companies enter the competitive

landscape of the future, they will shed the last remnants of their old, rigid vertical structures and their limited

geographical footprints.

6

There will be significant changes in the way energy and utilities companies are organized:

� First, class-leading companies will decentralize their organizations functionally so they can direct manage-

ment resources to where they will be most productive – freeing senior corporate executives to focus on top-

level strategic issues, and concentrating the efforts of business unit leaders on operational strategies and

tactics for their unique markets.

� Second, the leading companies will accept the notion that different businesses merit different management

approaches and cultures. Affiliated business units need not be clones of one another in terms of internal

structure and management philosophy, to say nothing of everyday operating policies. Thus discrete business

units will be allowed to develop their own cultures as befits their unique market situations.

� Third, successful companies will fully embrace their roles as competitive players in an unforgiving market-

place. This step might seem simple, but in fact it is agonizingly difficult. It will require companies to under-

take stem-to-stern assessments of their management competencies, market positions and operational

systems. Such thorough examinations will lead to significant organizational changes, some of them painful.

� Finally, the very best companies will go one step further: incorporating performance management and

business intelligence systems into all major facets of their operations. This will allow executives to continually

monitor the effects of business decisions, providing the feedback they need to fine-tune their organizations

for higher levels of efficiency and productivity on a near real-time basis. The fortunate few that survive to

“super major” status will fully embrace the concept that knowledge is power. They will understand that the

future of the energy and utilities business lies as much with harvesting and leveraging information as with

managing assets.

The Path to ValueTo achieve aggressive growth rates, energy and utilities companies will need to escape the geographic and

regulatory boundaries and structures that have

constrained – and protected – them in the past.

Accomplishing this will present executives with

profound challenges in terms of the structural and

cultural changes. Even so, great rewards await

companies that can successfully unleash their competi-

tive potential.

The following sections analyze the industry’s evolution

toward a more dynamic and rational business model,

and provide guidance for companies seeking to

navigate the treacherous waters of transformation.

The first section, titled “Drivers of Change,” explains

the factors that will affect a transformation in the

industry. The second section, “Portfolio Strategies,”

discusses how companies can apply portfolio strategies

in an active and aggressive manner to realize the

greatest financial benefit from their reconfigured

businesses. The final section, “Organizational Impera-

tives,” considers the organizational, management and

cultural imperatives involved in implementing a

portfolio strategy.

Why California Failed

The reasons for the California electricity crisis of 2000-2001 are

complex and varied. Some of the key causes include the following:• Breakneck economic expansion (and therefore load growth) came

during a period of market immaturity and supply shortages.

• Onerous competitive transfer charges discouraged newmarket entrants.

• Regulatory requirements that utilities purchase all electricity onspot markets created barriers to risk hedging.

• Absence of retail price signals disconnected wholesale costs fromretail rates.

The Federal Energy Regulatory Commission (FERC) staff report in

response to price spikes in the Midwest two years earlier might have

offered some preventive treatment for California: “The fact that retail

customers had no incentive to adjust their usage based on price

contributed to the price spike. Retail competition, coupled with the

ability to respond in real time … would help reduce the amount of

power utilities would need to purchase … and allow for greater choice

for customers.”

The moral of California is that an incomplete competitive market is a

dangerous structure. Utility regulators need to plan carefully their

industry’s timely transition from a rate-regulated regime to full retail

competition with clear price signals.

Source: www.ferc.gov

7

Drivers of ChangeFour emergent forces will drive the reformulation of the utilities and energy sector over the next five years:

� Deregulation and restructuring of energy markets

� Growing demands of capital markets

� Diminishing opportunities for domestic growth

� Increasing use of outsourcing and enabling technology.

Deregulation:

Liberalization and restructuring have been the dominant regulatory forces driving the industry’s initial disaggre-

gation. National markets such as the UK, Norway, Singapore and Australia demonstrate the success of introduc-

ing competition into the generation – or wholesale – market and providing access to consumers through

independently managed transmission networks. Open access has also proved to be equally successful in gas. In

addition, some jurisdictions have achieved notable success in the retail market. For example, the UK has

experienced switching rates of around 30% in both the electricity and gas residential markets, and switching

rates in commercial markets are even higher. Generally speaking, liberalization is proceeding, and regulatory

structures are improving with time and experience.

Some markets, however, will experience delays and even backsliding in their evolution. The United States and

Australia provide vivid examples.

The U.S. regulatory framework does not support a complete unbundling – distribution and retail functions in

most states will remain combined for the foreseeable future. Considerable skepticism persists over the cost-

effectiveness of competitive retail energy markets in the U.S. Further, such forces as economic recession, the

California-market debacle and Enron’s collapse have served to set back restructuring efforts.

These setbacks, however, seem unlikely to permanently derail liberalization progress. As a case in point, the

state of Texas introduced retail choice on schedule in January 2002. Texas’s restructuring laws appear to avoid

most of the pitfalls that plagued California. Whatever the outcome, Texas promises to serve as a critical test of

retail competition in the United States.

Restructuring efforts appear even more precarious in Australia. Privatization activities have ceased, and progress

toward retail competition has yielded meager results. In the few areas where retail choice exists, the market

remains nascent at best. Australian lawmakers currently have little stomach for restructuring given the mixed

results of deregulation.

Europe, conversely, seems much less prone to retrenchment in its progress toward retail choice. Retail competi-

tion is already under way in Germany, Austria and the Scandinavian countries. Other European nations are

looking closely at these examples – as well as the UK’s experience – as they prepare to meet the obligations of

the EU Utilities Directive. This Directive in progress calls for retail electricity choice throughout the European

Union by January 2003 (January 2005 for residential customers). Under current proposals, gas customers would

get to choose their suppliers in January 2004 and 2005.

8

Thus, despite short-term difficulties, progress toward a liberalized energy and utilities market will continue, and

companies with growth aspirations will plan their strategies accordingly.

Capital markets:

As energy and utilities companies become more reliant on raising investment capital from the financial markets,

short-term financial performance and shareholder value will become all-important. This poses significant

challenges for energy and utilities companies, which must balance long-term strategic goals against immediate

market demands. Long-term decisions, such as power plant investments, need to compete against the somewhat

shorter-term views of investors and analysts.

The capital markets will continue to dissect the industry and its players to understand where the long-term value

resides, and this analysis will become more and more sophisticated. Weather conditions will no longer be

accepted as the end-all explanation of deviations in earnings results. The advent of mark-to-market accounting

forces analysts to focus on cash flow as well as earnings in their analysis of the industry. Raising capital in this

market will challenge energy and utilities companies in new ways.

Over time, the capital markets will become more sensitive to the risks of volatile wholesale markets and their

implications for retail markets. For most electricity players the results to date have been negative. In the future

companies will have to convince the markets that they have clear strategies for survival and success in the new

competitive world. Those unable to tell a compelling story, produce sustained performance and build a balance

sheet robust enough to withstand the boom-bust cycle will see greater erosion in their share price over time.

Unbundling offers companies the opportunity to focus their strategies, exploit scale economies and to increase

value growth through innovation and global expansion.

Diminishing opportunities for domestic growth

As utilities and energy companies continue to pursue

economies of scale, they will rapidly outgrow the

domestic opportunities for growth. This will drive them

toward cross-border growth.

Momentum will come from:

� Need for scale economies: Companies will apply

competencies on a world scale, and consolidate

relationships with suppliers. This translates into

a key competitive advantage for global players.

� Privatization: Privatization began the globaliza

tion trend by allowing companies to acquire

privatized properties and advance their global

positions. This trend will allow companies to

diversify their regulatory and country risks.

� Need to grow earnings: Faced with limited

growth prospects in their home markets, due

either to slow growth or market-power issues,

most companies have little option but to move

outside their borders if they want to grow

earnings.

Agile Endesa

No longer owned by the Spanish government, Endesa represents one of the

most aggressive and dynamic players in the global energy and utilities industry.

The company is one of the largest energy utilities in the world, with an installed

generating capacity of about 35,000 MW. Endesa serves some 20.5 million

customers in 12 countries. The company is diversified into utility related

businesses, with domestic holdings in telecom and gas, and growing wholesale

and retail energy businesses in Europe and South America. It has established

an imposing presence in South America, with significant wholesale and retail

operations in Chile, Argentina and Brazil.

Endesa is organised into six business units, focusing on generation, distribu-

tion, marketing, international holdings, new ventures and internal services. The

company manages its portfolio dynamically, and as an example, Endesa has

recently sold a power distribution company – serving about 500,000 customers

– and power plants totalling 2,300 MW of generating capacity to Italy’s Enel

and on the other hand it has acquired 5,700 MW in Italy and 2,700 MW in

France. Endesa has consolidated the rest of its regional utility holdings into a

single business unit, while keeping a geographical presence.

The company’s presence in Argentina has caused concern among analysts.

Endesa reduced its holdings in Argentina last year, but the country’s economic

crisis could hurt Endesa’s earnings this year. The impact, however, is likely to

be small, since less than 3% of Endesa’s assets reside in Argentina.

In the longer term, Endesa should continue as a strong global contender.1

1 Endesa S.A. website (www.endesa.es).

9

Ownership patterns are already becoming global, and this trend will continue. American companies such as Duke

and TXU are major participants in Europe, Latin America and Asia, and the previously “national” European

companies, including Endesa of Spain, are investing heavily in other European countries, the Americas and

elsewhere. In all markets, knowledge of local situations – political, customer and site conditions – will play a

decisive role in success.

However, the race to achieve global positioning is increasingly creating value dilemmas. For those building scale

through acquisitions, typical asset prices for existing businesses in the power sector are high. Only those

companies with great financial clout, combined with long-term insight on the market, can sustain current

acquisition prices for assets.

Outsourcing and Enabling Technologies:

New information technologies make it possible to outsource an increasing variety of functions. This encourages

disaggregation and horizontal corporate structures. The last decade of technology development has been

phenomenal. These advances give companies the ability to gather and process information far more efficiently

than in the past. This allows companies to analyze options and make decisions at amazing speeds. In the next

few years, the speed with which companies are able to do this will be an increasingly important competitive

weapon. In addition, these technologies have become much more cost efficient. The software revolution – as well

as such “soft technologies” as innovative contractual agreements – will allow utilities to reduce costs, improve

performance and focus resources more productively.

The trend toward outsourcing is already well established, with utilities outsourcing many functions – from tree-

trimming to plant construction. In the next few years the advent of new enabling technologies will elevate this

trend to a significant role in driving the industry. Whereas in the past utilities have avoided outsourcing some

functions because of pure control issues, enabling technologies have helped alleviate this concern by making

outsourced processes transparent to the end user. Focusing on the core business will make this a key driver in

the industry.

Customer data-management and call centers are two obvious examples of business functions that can be

outsourced effectively. Others include facility operations and maintenance; engineering, procurement and

construction; accounting; training; and meter reading.

Finally, the outsourcing trend will give rise to a new class of outsourced service providers. These players will not

focus exclusively on the energy and utilities industry, but will operate across multiple industries and geographic

boundaries. These emergent service providers will meet both general infrastructure needs such as information

technology and administrative business processes (i.e., finance and human resources) as well as specialized

needs such as distribution operations and customer service. Companies like 24seven have begun to offer these

types of services.

Customer information systems (CIS) is just one area where utilities companies can benefit. Driven by complex

regulation and billing arrangements, utilities have invested heavily in their CIS infrastructure. The changing retail

landscape will call for continued investments. In the future, companies will look outside their four walls to meet

these needs, and CIS service providers will emerge to fulfill this function.

10

Advent of Four Business ModelsThe previous section examined the drivers transforming the utilities and energy sector. Here we discuss the

implications for key market segments.

Although all companies have not yet restructured themselves into horizontal business units or corporate entities,

the industry itself is already splintering along business lines.

Most obviously this disaggregation affects energy and utilities companies’ operational processes, but just as

importantly it is forcing them to reconsider their business strategies and market positions. As they do so, they

will identify core business areas or segments.

By 2007, four business models will dominate:

� Retailing

� Distribution

� Transmission

� Merchant Energy.

ModelCoreCompetencies

Risk/Reward Traits

Retail

Distribution

Transmission

Merchant Energy

Four Models

Source: IBM Business Consulting Services

Leader Profile/ Examples

Strategiesand Tactics

KeyRisks

Branding;Marketing;Data mining;Building alliances;Cost control

High Risk; High earnings, low margins

National and regional service providers with customer-centric culture

Forge marketing alliances; Expand into new geographic areas with one product, then expand product line; Maximize customer value by bundling products

Fierce competitive environment - efforts can provide bait for competitors; Lack of diversity increases systemic risk; Expansion depends on functional expertise

Engineering;Field-force management;Cost control;Government relations

Low risk; High earnings,low margins

Utilities who operate distribution networks

Expand geographically;Leverage rights of way;Ruthlessly manage costs;Optimize core processes, outsource others;Negotiate for discounts with network and metering technology companies

Force majeure;Inability to control costs; Advances in distributed generation

Engineering; Network management; Government relations; Market analysis and risk management (for merchant transmission)

Medium risk; medium earnings

Utilities who own significant transmission assets

Achieve scale economy through acquisitions; Apply cost-control and system optimization expertise; Develop new assets in areas with constraints or complementary loads

Force majeure;Regulatory risk;Advances in distributed generation;Inability to predict changes in load

Trading, marketing and risk management; Valuation and analysis;Facility operations

High risk; Medium earnings, high margin

Merchant power companies; Utilities with substantial generation assets; IPPs; Gas suppliers

Take phased approach to geographic expansion; Control costs; Exploit volatility;Manage risks

Market risks;Lack of geographic diversification at outset; Geographic expansion opportunities come and go quickly

11

Rising above these will be the super majors – a handful of integrated global entities that will combine all or

some of these business models to create superior value.

As companies align themselves with their core competencies they will develop separate businesses along these

lines. These businesses will be operated separately because the four business models are fundamentally

different from each other in terms of risks, rewards, business processes and critical factors for success. For

example, managing a local distribution system requires skills that are heavily centered on engineering and field-

force management and managing the regulatory relationship. Effective retailing, however, requires strong skills

in branding, marketing, channel exploitation and customer-data management. These two business areas are

dissimilar in every way – with the exception that they both play a role in linking end users with energy supplies.

Successful players will require skill sets, management styles and capital structures suited to the demands of

their specific business areas. Trends in this direction are already evident, with companies forming dedicated

business units and even separating those units from the corporation. The four business models discussed here

represent the culmination of this trend.

RetailingFrom a risk-versus-reward perspective, retailing is a relatively high-risk, high-reward business area. Success

depends heavily on achieving economies of scale in IT, call centers and marketing – with a critical mass being 8

to 10 million customers. Airtight cost management and information-analysis skills are also required. Managed

correctly, retailing offers significant earnings and growth potential, but low margins, typically in the low single

digits. Success depends on staying in the game, acquiring customers and territory while others are gobbled up.

Margins will be particularly depressed through this shakeout period.

Successful retailers will focus on acquiring a large-enough customer base to achieve profit from scale efficien-

cies. They will seek to profit from their ability to segment and capture key customer groups, drive down costs per

transaction, and minimize the rate of customer churn.

Some will also seek value by cross-selling a range of diversified products and services – including telecommunica-

tions and financial services. Typically this will be through reseller arrangements with telecoms and financial

companies. Such arrangements will allow retailers to garner economies of scope.

For multiservice companies, success depends on the ability to create brand and service strategies that respond to

underlying customer needs. For example, Centrica is

pursuing a multiproduct, multimarket business model.

Brands and relationship management will continue to

depend on local market characteristics, and many

brands will retain a national or local identity. Some

players will find value, however, in extending brand

identities across borders. Back-office efficiencies can

be achieved through careful international expansion,

and leading retailers will leverage their partnering,

contracting, management and finance competencies on

a global basis.

Snapshot: Centrica plc

Who they are: Energy retailer formed in 1997 from the demerger of British

Gas plc into Centrica and BG.

Customer Base: About 13.4 million gas customers and 5.4 million electric-

ity customers in the United Kingdom, plus overseas presence through

Energy America and Direct Energy in the Americas, and Luminus in

Belgium.

Key Assets: A significant stake in gas fields and power plants.

Strategy: Centrica is pursuing a multinational, multiutility retail strategy.

The company markets retail gas and power with telecoms and insurance

services, and gains value through both scale economy and added-value

product marketing. Further, the company hedges its supply risk with

physical assets, including gas reserves and power generating capacity.1

1 Centrica plc, Annual Review and Summary Financial Statement 2001.

DistributionElectricity and gas distribution will remain regulated monopoly activities, with low-risk, low-reward characteris-

tics. In these regulated environments, distribution companies will reap steady cash flow, but growth options will

be limited to geographic expansion through acquisitions. Aggressive and proficient distributors will acquire

poorly managed distribution properties – or provide outsourced asset management services to the asset owners

– and strive to improve their performance. They will do this through the application of standard processes that

are repeatable for numerous acquisitions.

Global players will increasingly dominate the distribution business area. These companies will gain global

expertise in regulatory frameworks, financial and asset management, supplier contracting and information

technology. They will operate in conjunction with local work managers who will deliver work scheduling, contract

management and field-force and local supplier management.

Distributors will attain additional economies by handling multiple utility services. In many countries, distribution

utilities already handle more than one product – most commonly electricity, gas, telecoms and water and district

heating. Integrating multiple types of network utilities can achieve two key benefits. First, where one business is

more efficient than the other best practices can be transferred, bringing both to the same level of efficiency.

Second, pure multi-utility synergies are possible through economies of scope in areas such as outsourcing,

operations management, and information technology.

Some distribution companies will also gain value by utilizing rights-of-way for cable and fiber-optic networks. But

the most significant way to increase profitability in the distribution business is to drive costs down through

economies of scale and disciplined operations management.

A secondary level of unbundling will take place in this market as distribution companies optimize the way they

manage their assets and outsource non-core functions. By consolidating redundant functions and negotiating

with suppliers for better prices, a larger distribution company will operate more efficiently than a smaller one.

Transmission

Long-distance transport businesses – including gas pipelines and high-voltage transmission networks – are

currently undergoing significant change, and hold substantial growth opportunities.

In many countries, the electric transmission business is growing ripe for consolidation. Regulatory constraints are

forcing many transmission owners to exit the business, which means assets are coming onto the market. Because

these assets have been owned and managed in a balkanized way in the past, opportunity exists to gain value by

integrating them into a more rational business. Innovative companies can add value with creative approaches to

pricing, ancillary services and the use of derivatives to manage risk.

Successful transmission players will be those that develop world-class competencies in assessing market

dynamics – namely, load curves and price volatilities – and target investments that take advantage of these

“bumps” in the market. Thus transmission players will depend heavily on their market-analysis skills, as well as

the ability to manage the regulatory frameworks in which they operate. Critical skills will include siting and

permitting, and innovation in finance and procurement to reduce costs. Leaders will seek to leverage these skills

across markets, while applying scale economies in network design, maintenance and IT architecture.

12

Merchant Energy

Companies pursuing this business model will own and manage a portfolio of generating plants and upstream fuel

supplies, and will leverage these assets in forward-trading activities.

Within merchant energy companies, two imperatives will dominate. First, companies will need to maximize plant

performance through effective operation. Second, they will need to manage price risk through effective trading.

The dissimilar nature of these two activities will ultimately demand that they be separated into different

management units under common leadership.

A successful generation group will optimize plant performance through effective operations management.

Innovative financing arrangements will reduce capital costs, and partnering and outsourcing skills will allow

successful energy merchants to leverage existing infrastructure and competencies.

Successful traders will apply sophisticated asset-valuation techniques in acquiring and developing new facilities;

and will manage price risk through effective trading. For the merchant energy business, having a balanced set of

skills will be necessary to maintain a superior market position.

The trend toward global merchant players will accelerate with the progressive privatization of some large

utilities. The long-term goal will be global market reach, but attaining such a goal will require a phased approach

– starting with the development of a portfolio of product offerings and establishing financial credibility in a local

market before expanding geographic reach.

Super majorsOver and above these four business models, a handful of global leaders will play in multiple parts of the value

chain across the globe. These players will reinvent the notion of an integrated energy/utility company, in effect

becoming the industry’s super majors. They will be

adept at raising large amounts of capital in the global

markets, which will allow them to dominate multiple

markets. Further, these companies will be more readily

able to invest across the energy and utilities value

chain, ensuring that they are well positioned for the

emerging competitive markets.

The super majors will manage a large portfolio of

holdings as an integrated business. Capital allocation

will occur at the highest level, ensuring that the

corporation as a whole optimizes its value. Local

management will be responsible for the operations of

these businesses, but will be given a set of perfor-

mance targets and operating guidelines. Corporate

leaders will manage the overall risk profile of the

entity on a global basis. These entities truly will be

powerhouses in the industry.

13

Managing Risk in a Portfolio

In the transformed energy and utilities landscape of 2007 hedging risks will be

crucial. This has particular resonance in deciding the optimal level of integration

and the make-up of a company’s portfolio. The ability to hedge across markets

and business units will ultimately determine the success of the strategies

adopted by individual energy and utility companies.

Only the most conservative utilities still maintain a vertically integrated posture,

but that does not mean these strategies are extinct. On the contrary, vertical

integration will find new life after the industry’s disaggregation as energy

companies seek greater value by leveraging the characteristics of different

businesses off one another. These new vertical structures, however, will be built

on a foundation of market drivers rather than regulatory ones.

Arguably shareholders could attain the same kind of diversity on their own by

simply investing in complementary horizontal businesses, but at this juncture

they seem to be rewarding companies for incorporating a hedged asset struc-

ture.

Eventually this posture may change, as markets mature and as companies

develop hedging mechanisms that do not require asset ownership. Oil majors, for

example, have largely exited the refining business to escape the environmental

exposures and market volatilities that refiners face, yet they retain access to

refining capacity with long-term agreements. Similar trends are occurring in the

electric and gas industries, where companies are divesting themselves of

transportation assets, but retaining firm rights to capacity on those networks.

Exploiting scale and scope economies will be fundamental to the success of these global companies – primarily

because their size will enable them to dominate more than one market and access larger amounts of capital at

better terms. When successful, this global strategy will generate more value than less integrated “international”

operations can achieve, increasing the gap between the truly global and the merely international.

The super majors will require different management techniques to international entities. Managing on a global

basis will mean more than just doing business in a number of markets. Synergies across business units (e.g.,

between merchant energy units and retailers or between different network businesses) and across borders will

constantly refresh and drive the global nature of the organization. The ability to apply best practices across the

globe will drive value in these organizations. Super majors will benefit from numerous competitive advantages,

including:

� Early warning of opportunities arising in numerous countries, via active participation in local markets.

� The ability to leverage resources and capabilities across business opportunities more quickly and

successfully than regional competitors. (This will depend on an organized approach to mobilizing

business development teams.)

� The opportunity to develop and implement best

practices around the world, and avoid the

“reinvention of the wheel” in market after

market.

� Access to better financing terms, by virtue of

their broader scope and scale of operations

and risks.

� A global network of individuals and knowledge

bases, which can help the entire organization

solve a variety of thorny business issues –

technical, managerial or process-oriented.

Truly global companies, the super majors will also

enjoy risk-management advantages. For example,

with businesses in many markets, they will earn a

steadier cash flow than smaller competitors with less

geographic scope. Further, by virtue of their global

diversification, the super majors will be better

positioned than smaller competitors to tolerate risks

in any given market. Such risks include:

14

Global Utilization Efforts in the US Utility Industry

The investment by U.S. energy companies in international assets began in

earnest in 1998, when several of the largest utilities made investments in

overseas assets of more than $250M. As the U.S. stock market peaked,

international investment exploded in 1999, multiplying over five-fold from

1998 and totaling nearly $20B. The level of international investment has

dropped off in parallel with the drop-off in energy company valuations in the

U.S. stock market, but there were still more than $6B in investments made by

U.S. companies overseas in 2001.

The globalization of US utilities can be seen in the increasing concentration

of buyers in each year. While seven international transactions in 1998 were

spread across six buyers, the picture changed significantly in 1999. Twenty-

four companies made a total of 60 global investments that year – but just

four of those companies accounted for 53% of these transactions. In the 87

transactions that have occurred since then, five utilities mentioned account

for 66% of the transactions. The message that can be gleaned from this is

that while many utilities are getting involved internationally at some level, a

handful appear determined to make their mark as true global players.

The geographic and asset diversification is also evident in the diversity in the

assets purchased by the most active asset acquirers. For example, one utility

initially began purchases exclusively in generation, but since 2000, has split

its investments roughly in half between generation and transmission and

distribution assets. This utility now has a significant asset base in Argentina,

Chile, and Peru, with other investments in Eastern Europe and Asia as well.

While foreign companies have not yet been as active in acquiring U.S. assets,

there have been some quite high-profile acquisitions made over the last few

years. Perhaps the most active in this market have been the utility companies

of the UK, completing one or more major acquisitions of U.S. utilities and

assets. However, other European utilities have recently made significant

investments in the U.S., and Canadian and Japanese companies have made

their presence felt as well. This shows that the evolution of super-majors has

begun.

� Market risks: Will our product be accepted in local markets? Do we know how to design, price,

promote, distribute and support in local conditions effectively, and profitably?

� Political risks: Are our operations subject to political upheaval? Do we know how to insulate ourselves from

political change?

� Regulatory risks: Do we know how to obtain the necessary regulatory approvals for sustained success? Do we

have effective regulatory relations? Can we develop them?

� Business cycle risks: Do we have the ability to balance the effect of business cycles across the world?

As the utility markets evolve, the super majors will reap long-term financial rewards far greater than the

specialty players. These rewards will allow for market dominance as well as access to the greatest amount of

capital. Indeed, capital-market access will be a key factor in determining the emergence of super majors. The

markets will seek and reward companies whose global portfolios allow them to manage the risks of the industry.

This is evident in the petroleum sector, where the majors are consistently rewarded with a higher price-to-

earnings ratio than the other players.

The emergence of the super majors, however, will not necessarily marginalize the other players in the industry.

These other players will have an important role in the overall industry value chain. They will also experience

periods of higher returns when their markets turn in their favor. But over the long run the super majors will

outperform the other players, maintaining momentum through downturns that might devastate smaller

companies.

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16

Making tMaking tMaking tMaking tMaking the Phe Phe Phe Phe Pororororortftftftftfolio Dynamicolio Dynamicolio Dynamicolio Dynamicolio DynamicThe previous section analyzed the emergent business models in the new industry structure. In this section we

examine the challenges energy and utilities companies must address to succeed in the new competitive land-

scape.

Regardless of what roles an energy or utility company will play in the new industry structure, it will need to

manage its business in a way that ensures it has the right portfolio of assets at the right time. Accomplishing

this will not be easy. Portfolio management skills will be a critical success factor.

Managing a dynamic portfolioThe concept of portfolio management is simple to understand, but hard to implement. A company establishes a

set of criteria for valuing properties, and then analyzes its business based on these criteria. Just as a financial

portfolio manager begins with a set of objectives regarding the investor’s risk, so too the corporate portfolio

manager bases decisions regarding capital investments and operations on a set of established corporate

objectives.

Such objectives involve earnings, cash flow and capital requirements.

� What are its profit margins?

� How much cash does it produce?

� Does it require a great deal of additional

investment or costly routine maintenance?

Other criteria might involve expansion opportunities.

� Does it occupy a growing market?

� Can it be expanded geographically?

� What is its growth rate?

Third, some criteria might involve the ability to derive synergies or scale economies.

� Can the property add value through its combination with another business?

� If it were consolidated with another organization, would savings result?

Finally, a set of criteria will focus on various types of risks.

� Does the property improve or degrade overall exposure to market risks, margin risks, regulatory or

political risks?

The corporate portfolio manager will shape the asset portfolio based on how individual properties perform

according to these established criteria. The risks the company is willing to bear will be balanced against

anticipated earnings and value propositions.

This does not imply that companies will buy and sell major fixed assets on a knee-jerk basis. Recognizing that

power plants and distribution grids are not exactly liquid assets, they will focus on a longer horizon and a bigger

strategic picture than a financial portfolio manager might. A corporation might “bank” under-performing

properties, because they offer site, market or risk characteristics that are expected to be more valuable in a

given time frame.

Two industry groups – petroleum and real estate – provide instructive examples. Leaders in these business areas

establish strategic objectives and continually re-evaluate the assets in their portfolio (and assets they might

want to acquire) against these objectives.

A real estate company, for example, will have a business unit that focuses on developing properties. Once the

development work is completed and the property is being leased and has sufficient cash flow, it is turned over to

a business unit that focuses on achieving cash flow and asset appreciation. A third business unit might focus on

valuation and acquisition. All three groups strive to meet the portfolio objectives of the overall corporation.

Optimizing the portfolioEach of the energy industry’s four functional business models – retail, distribution, transmission and merchant

energy services – has unique considerations regarding asset ownership and asset management. Companies that

are integrated across more than one business area will have multiple business units pursuing these businesses

under the same corporate umbrella.

One level of portfolio management will occur at the business unit. In the merchant energy business, for example,

the business unit leadership will make decisions about individual facilities and other assets in an effort to meet

or exceed corporate objectives. If this merchant business unit is contained within a holding company that is also

involved in gas pipelines and electric and gas distribution, then another level of portfolio management will occur

at the holding-company level. The corporate portfolio manager will consider the performance of business units to

determine how to allocate capital and management resources.

Periodically, management will extract earnings or capital from one business to invest in another business. Even

presuming that all the businesses might be self-funding if left to their own devices, the corporate portfolio

manager might perceive opportunities for creating more value by diverting resources from one to another. For

example, an integrated company might move capital from the distribution business into the merchant energy

business if it is considered more strategic in the overall company view.

Integrated oil and gas companies regularly carry out this kind of asset shuffling – buying and selling properties

and facilities, based on the results of different portfolios and changes in the external environment. Naturally

portfolio criteria change as market conditions and corporate objectives evolve.

For the energy and utilities industry, the merchant business model will benefit the most from a portfolio

approach. This is where the commodity is actually being produced, and the assets themselves are the most

mobile – that is, they are easy to buy, sell and integrate into a system.

A distribution system, on the other hand, tends to be a very large and geographically dispersed asset that is not

easily split into smaller units. Certainly distribution systems change hands and will continue to do so, but

assimilating such an asset is orders of magnitude more complex than integrating a gas field or power plant.

17

That said, companies with distribution assets can still benefit by including those assets in a portfolio-manage-

ment strategy. For example, to the degree that smaller distribution systems exist as islands within larger ones, or

adjacent systems have overlapping or “checker board” areas, properties may be swapped to achieve efficiencies

for both systems.

Further, as distribution continues evolving horizontally – with regional and global consolidation to achieve scale

economies – distributors will pursue a portfolio approach in acquiring and liquidating properties, as well as

making investments to improve performance. Companies might seek to acquire poorly performing properties

with an eye toward improving them with new technology and management practices. Then they can either sell

such properties or continue to operate them, as best fits their strategic objectives.

The point is, in the new world nearly every asset will have some optionality. The companies that extract the most

value from the portfolio management approach will be those that are willing to value properties holistically and

objectively, and to take action based on how those valuations compare to their established criteria.

Adopting sophisticated asset valuation techniquesIn the past, companies have tended to value acquisition targets based on their simple lifecycle performance. For

example, a power plant that operates an average of 3,000 hours a year and produces mid-load power will

produce a certain amount of revenue based on certain price projections. Subtracting the plant’s operating costs

yields its annual value to the company, and extending the same algorithm over the expected life span yields its

lifecycle performance. Adjusting this for inflation and other factors provides a basic appraisal of net-present

value.

In the new world, however, such a simple approach to valuation will be woefully inadequate because it fails to

account for the plant’s option value – that is, its role as part of the overall portfolio. A smart merchant energy

company does not operate a plant according to a statistical average. Instead it operates it based on the plant’s

unit cost of output taken in context of the company’s other options, and compared to market prices for electricity

and fuel at the given time. Determining a plant’s true value, therefore, requires a much more sophisticated

analysis of probabilities, based on many external factors. This is what we mean by stochastic valuation.

The skills to carry out such stochastic valuations will help companies make their portfolio management strate-

gies more dynamic and adaptable to the changing marketplace. But just as important will be the willingness of

corporate management to put the portfolio-based analysis into practice. This will require companies to evolve

from the old-world mentality about utility assets – namely that they are static investments with little or no

chance of being sold once acquired – toward a more flexible, options-based view of the world.

18

Practicing risk management across markets and business unitsA further step beyond dynamic portfolio management is the practice of enterprise risk management – or

hedging. This expands the portfolio-management concept across all the types of risks that a company faces.

Examples are sovereign risks in different countries, currency exposures, and exposure to fuel prices across a

global business rather than just within a discrete business unit. A company that takes an enterprise view of risk

will seek hedges against exposures that another company might ignore.

This more sophisticated, holistic view of risks and rewards will position a company to operate more effectively in

the complex global marketplace. In the new world, part of the rationale for vertical integration arises from the

desire to create a physical hedge against price volatility. In a commodity market, the only way to create value

with the commodity is to change either its state or its location. In the gas and electricity business, this means a

company will find opportunities for creating value at several steps in the journey from wellhead to end user.

By controlling logistics and facilities at each of the critical links in this chain, companies will create value and

save costs.

Commodity businesses are cyclical, with periodic surpluses and shortages. The ability to control a portion of the

supply at each step of the value chain provides a physical hedge against price volatility. In other words, if a

company owns product or controls capacity on a certain facility, it will be less exposed to price changes involving

that product.

The degree to which a company needs a physical hedge – as opposed to a contracted one – is a matter for

debate. But practically speaking, physical ownership represents a more secure asset than a contract. During

market dislocations – where supplies are constrained and prices spike – contracts may not prevent financial

disaster for a company that finds itself too short or

too long in the market.

Thus the desire for a physical hedge will drive

companies to reaggregate different assets. This

process is already evident. Examples include American

companies Duke Energy (See “Snapshot: Duke

Energy”) and El Paso Energy, which control gas

processing assets, pipeline capacity and trading

capabilities; and Centrica (the de-merged retail

segment of British Gas), which owns gas fields, power

plants and a large retail marketing organization.

19

Value-Chain Opportunities

Changes in State:

� Extracting fuel from the ground;

� Processing fuel;

� Storing fuel or electricity;

� Burning fuel to generate electricity;

� At the meter, where consumption data iscollected; and

� At bill presentment and payment, where

consumption converts into money.

Location Changes:

� Fuel moves to the processing plant;

� Fuel or electricity moves into storage;

� Fuel moves from the processing plant(or storage) to the burner tip; and

� Electricity is transmitted from the generatingplant (or storage system) to the distribution

system, and ultimately to the end user.

A second argument for vertical reintegration involves hedging on a broader business basis – i.e., diversifying in

businesses with complementary risk profiles. For example, generation and trading businesses face a high degree

of market risk, but distribution companies are generally protected from these risks. Holding assets in both areas

can provide the upside benefits of the high-risk trading business, plus the stability of the steady-state distribu-

tion business.

Aligning strategic and operational prioritiesAlong with the new capabilities of dynamic portfolio management, to succeed in the new competitive environ-

ment energy and utilities companies will also require an overhaul of existing capabilities.

Operational priorities must be aligned with emergent strategic goals. Companies need to identify and communi-

cate key milestones, and ensure the efficient flow of critical performance data and other information across the

enterprise. At the same time, they will need to keep a tight rein on the cost structure by taking advantage of

outsourcing, shared services and economies of scale.

For most companies this will require a thorough examination of their strategies, skill sets and processes. They

will update and clarify their strategic objectives, and establish a strategic scorecard that will be used to measure

progress toward the objectives through leading and lagging performance indicators. These indicators will be

cascaded throughout the organization, and tightly linked to the corporation’s global objectives.

Next they will analyze their business processes, competencies and market positions at each critical link in the

value chain, especially those links that are deemed most important to the company’s core strategy. Connecting

the value-chain analysis to the priorities outlined in the scorecard will bring focus to the business analysis, and

will provide an objective benchmark for measuring performance.

The next step is to build the necessary process and

technology infrastructure. Throughout the organiza-

tion, a standard architecture will be required for

operational processes, information technologies and

management competencies. Companies will use this

architecture as they continue to expand on a global

basis. Establishing this infrastructure early represents

one of the biggest challenges that companies face,

but those that can accomplish it quickly will gain a

competitive advantage.

GE’s Culture

While General Electric has many business units that operate with

great autonomy, the company demands strict uniformity in financial

reporting. Indeed, visibility into operational performance is a critical

element of GE’s continued success.

Additionally, GE promotes a common culture centered on its shared

values. Examples of these values include an emphasis on innovation

(“an endless search for ideas that stand or fall on their merits, rather

than on the rank of their originator”) and lifelong learning (“our true

‘core competency’ today is not manufacturing or services, but the

global recruiting and nurturing of the world’s best people and the

cultivation in them of an insatiable desire to learn, to stretch and to

do things better every day.”)1

Such values are not specific to any business model. They can be

applied uniformly throughout the organization, and they do not

impose an operating approach on anyone. GE is quite firm in the

areas where it needs conformity, but it seeks to minimize those areas

and allow a high degree of autonomy outside of them.

This allows GE to have the best of both worlds – horizontally focused

business units with unique cultures, and integrated approaches to

key corporate functions.

1 General Electric Company 2000 Annual Report, p.9 and p.4. 20

Building compatible culturesChanging infrastructure and processes is difficult enough, but changing corporate cultural traits is even more

challenging because they are firmly embedded in people – many of whom have been with the company for a long

time. Yet companies that attempt to restructure without addressing the need for new systems and leadership

skills will find their efforts falling short of the mark.

In the new competitive landscape companies will need new skills and ways of working. Old-style energy and

utilities organizations will not be well adapted to the demands of a disaggregated, multinational business.

Competitive pressures will force companies to develop a clearer understanding of their strategic positions, and

then to recast their management practices and operating structures in ways that better match the market

opportunities they are pursuing. Leading companies will develop world-class competencies in outsourcing, multi-

national business and portfolio management.

Companies with a rigid, command-and-control architecture are likely to resist this process. Because their cultural

values are deeply embedded throughout the organization, changing those values to reflect a new, competitive

strategy may require significant management retooling. In some cases existing leaders will adapt and assimilate

new attitudes, but many companies will need to seek new leaders with non-utility backgrounds.

Leading companies will foster greater business unit autonomy, and indeed disaggregated business units will

develop distinct workplace cultures. At the same time, though, companies will need to develop integrated

processes and management systems across the corporation. Companies that buy assets but fail to integrate

them will not capture the scale, synergy and risk-management benefits they seek through those acquisitions.

Thus the effort to decentralize tactical and operational structures will be balanced by a focus on optimizing

enterprise-wide processes.

To achieve this balance, companies will need to analyze their operations and determine what common platforms

are required for business units to serve collective goals. For example, wherever a company touches customers or

investors, uniformity is likely to be required. Common platforms therefore would include financial reporting,

investor relations and customer-facing functions.

Once these platforms are established, executives will

be better able to evaluate different units’ performance

consistently. An example of this approach can be found

in General Electric (see “GE’s Culture”).

Using this balanced approach, companies will be able

to embrace the cultural diversity that will foster

innovation and excellence, while preserving elements

that allow visibility into business unit performance and

uniformity in critical interactions.

Snapshot: Duke Energy

Who they are: Integrated electric and gas company based in the southeast

United States. Manages and delivers products throughout

the North America and key markets globally.

Customer Base: About 2 million electricity customers in North and South

Carolina, plus wholesale customers in gas, power, transmission, telecommu-

nications and other areas.

Key Assets: Power plants, pipelines, gas processing and storage facilities.

Retail electric in the Carolinas and gas distribution in North America.

Strategy: Duke is a broadly integrated company that pursues an aggressive

portfolio-management approach. Its key strengths are its size, diverse

portfolio and leading position in numerous attractive businesses. Duke

distinguishes itself by hedging physical assets to produce stable and

consistent earnings, even though it is involved in cyclical and

volatile markets.1

1 Merrill Lynch analyst report, 11/13/01.

21

22

Conclusion

Delivering Long-term ValueIn the years to 2007, energy and utilities companies face a unique set of challenges. Competitive forces and

regulatory pressures that are already pressing in upon them from all sides will intensify, triggering profound

changes within the industry. To succeed in the transformed environment traditional companies must analyze their

business propositions and determine the strategies most likely to bring them success in the long run. This

exercise will lead them to undertake a complete rebuild of their organizational structures, and to adopt a more

dynamic way of valuing property and allocating resources going forward.

As if these changes weren’t enough, companies will be driven to assess and re-cast their leadership profiles,

focusing on the competencies and attitudes required for success in the new competitive environment. Taken

together, these changes represent a stem-to-stern transformation of the energy and utilities business – a

transformation that has already begun, but will take several years to complete.

At the heart of this set of challenges lies the opportunity to build something new; something better than before.

Gas and electric companies face the prospect of redefining their role in the world – going from entrenched,

monopolistic utilities to competitive, innovative and dynamic businesses.

In this role, a whole new world will open up for energy companies – a world that is at once more complex and

hazardous than the old one, but also more exciting and rewarding. This world will cultivate excellence, efficiency

and innovation, rewarding the fittest and hardest-working with growth and value beyond anything previously

imaginable.

The key to embarking on this transformation centers on a refocus on the core. Companies need to reevaluate

their strengths in the new industry model and focus business strategies and tactics to capitalize on those

strengths. This evaluation will lead the enterprise to a focus on one of the business models or the global super

majors. Regardless of this decision, there are some steps critical for ensuring continued competitiveness in the

new industry landscape:

� Embrace Portfolio Management: Develop and employ a comprehensive set of portfolio management systems

and processes to enable dynamic management of assets. This needs to include more sophisticated valuation

techniques. The traditional utility maintained a set of assets that optimized regulatory requirements. The

new model utility will focus on a portfolio of assets that optimizes its business value.

� Develop an Enterprise View of Risk Management: Balance financial, operational and regulatory risks across

all businesses and markets to provide effective hedging. Traditionally, utilities have taken a narrow view of

risk, which in the future will need to expand.

� Align Strategic and Operational Focus: Match strategic goals with Key Performance Indicators and provide

the business intelligence to drive effective decision-making. Drive usable information to all levels of the

organization and incorporate such intelligence in decision-making processes. Information has always been

abundant at utilities, but it needs to be synthesized and disseminated in usable formats to all levels of the

organization.

� Continue the Focus on Cost: Enterprises need to continue to maintain cost-containment focus by taking

advantage of outsourcing, shared services and new information technologies. Even though traditional

regulation does not reward these efforts, they are mission critical for success in the new industry model.

� Build Cultural Capability: Transform the organization – including structure, personnel, systems and culture –

to match the companies’ strategy and market structure. Utilities have begun changing their culture to a more

competitive one. This needs to be balanced in its approach.

Overall, enterprises need to have a business model focus rather than a regulatory focus. Over the past decade,

utilities have begun to operate as competitive enterprises. Moving these operations to the next level remains a

challenge. Companies will need to manage a balanced set of regulated and unregulated assets on a competitive

basis. Companies that embrace these challenges and opportunities will be well positioned to reap the rewards

of competition – and to define their role in the new world.

1 The target date of 2005 will vary according to the regulatory regime in each jurisdiction.

2 General Electric Company 2000 Annual Report, p.9 and p.4.

3 Centrica plc, Annual Review and Summary Financial Statement 2001.

4 Merrill Lynch analyst report, 11/13/01.

5 Dow Jones Interactive, 1/17/01.

6 Business Week; Special Report: The Top 25 Managers, Richard B. Priory Duke Energy, 1/14/02.

7 Endesa S.A. website (www.endesa.es).

23

About IBM Business Consulting ServicesIBM Business Consulting Services (www.ibm.com/services) is one of the world’s leading providers of manage-

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24

Authors:Colin D. Sawyer — London+44 20 7968 7042

F. Michael Valocchi — Philadelphia+1 215 575 5093

please contact

To learn more about our global Energy & Utilities practice, please visit

http://www.ibm.com/services/strategy/industries/utilities.html

or contact an IBM Business Consulting Services representative.

www.ibm.com/services

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