Managing Director & Partner
San Francisco - Bay Area
Utilities are under intense disruptive pressure. In the 20th century, successful utilities typically operated as integrated, centralized monoliths catering to a captive customer base that had few alternatives for power. They enjoyed high demand growth and focused on long-term capital investments to expand their networks. But in the past few years, sweeping market changes have upended this traditional model. In the future, utilities will have to contend with a portfolio of decentralized and intermittent energy sources, as well as with stagnant demand, a slew of new technologies, and consumers whose interactions with other industries have accustomed them to a higher level of service and responsiveness. This dizzying array of changes is the result of at least six distinct factors:
These changes require an overhaul of utilities’ operating and business models even more extensive than the one that came with the deregulation and generation divestitures of the 1990s.
Too many utilities, however, either deny that the threats of a changing market are imminent or address those threats only incrementally. BCG has found that defensive transformations focusing on short-term victories, rather than on the capabilities required for long-term success, destroy the value of the business. Successful companies start their transformations before a significant downturn in performance has occurred. In fact, such proactive transformations generate seven times the value of defensive transformations. (See Transformation: The Imperative to Change, BCG report, November 2014.) A proactive transformation will take advantage of a utility’s unique assets, exploiting trends rather than merely mitigating their impact on yesterday’s business model.
Before beginning the transformation process, utilities must define their goals and select a business model. Top executives must clearly articulate their vision so that the entire management team understands and agrees with the goals, commits to making the necessary changes, and can plan to engage employees throughout the organization. The business model must articulate customers’ needs and provide a clear revenue model based on the products and services that will meet those needs. Whether the utility chooses to become a grid services provider or to adopt a more conservative, asset-based model in support of future infrastructure needs will help determine the nature of the transformation.
The transformation that utilities must undertake requires significant effort, planning, and commitment, and utilities need a strategy that flips the odds of success in their favor. While most observers focus on the inherent weaknesses of incumbents, utilities in fact have unique strengths to leverage in the new environment. BCG has helped several utilities around the world develop an approach to embracing and thriving in this rapidly changing marketplace. Regardless of the business model they select, utilities can succeed by developing a strategy based on five pillars. (See Exhibit 2.)
Utilities’ aging transmission and distribution infrastructure will require an $880 billion investment over the next two decades, according to the Edison Foundation1 Notes: 1 Edison Foundation, Transforming America’s Power Industry: The Investment Challenge, 2010–2030, November 2008. . To provide the superior service and consistent electricity supply that customers expect, grids must be upgraded to handle new technical capabilities, and utilities must invest in resiliency enhancements in the face of increasing threats to cybersecurity and to physical assets—whether from terrorist attacks or natural disasters.
As DER proliferates, operators must adapt grids to bidirectional power flows. The growing use of behind-the-meter generation, such as rooftop solar, has caused overvoltage and other problems on primary and secondary circuits. Addressing these issues will require investments in a wide variety of technologies, including advanced inverters, grid management and dispatch, and distribution-level energy storage.
Demand response can reduce the stress on generation assets and the need for grid investment by enabling customers to control their power consumption. With smart meters and hourly pricing, utilities can price appropriately during periods of peak demand and improve network operations. This will require investments in advanced metering infrastructure and grid management. Utilities can also use the real-time data collected to improve their reliability and customer service, or they can capitalize on their access to the customer data needed by nonutilities, such as solar installers and developers of smart-home software, to target their own product offerings.
In geographically isolated areas or in areas where most of the generation comes from distributed energy, utilities should consider integrating microgrid technology to avoid stranding existing grid assets. Deploying innovations such as net metering can also help lower utilities’ investment costs in the grid, which is vital to maintaining competitive rates and avoiding a rate return squeeze.
DER systems pose significant challenges to utilities’ business models and grid functions, but their growth is undeniable. Costs for rooftop solar have fallen by more than 70% since 2005, and these installations are expected to grow at an annual rate of 25% through 2020 in the US. During the same period, DER will expand to include technologies such as distributed storage, whose cost is expected to decrease by 40% to 50%.
Integrating DER into the grid is inherently difficult because it involves multiple stakeholders and cuts across many generation and distribution functions. Utilities must balance customers’ demand for interconnection options such as battery storage and rooftop solar installations with the economic impact on non-DER customers. They must ensure grid safety and reliability and an equitable tariff policy for all customers, while also addressing the implications of DER for technical integration and the design of grid processes and business models.
Tariff Design. As the use of DER grows, customers will want to participate actively in the grid. This will require tariff structures for DER (such as PV and storage ) that reflect the value of the electricity that customers both receive from and provide to the grid. Existing regulatory proceedings address this topic, especially with respect to net energy metering, which allows customers to offset electricity from the grid with power that they produce themselves. Such regulatory approaches can educate regulators and the public on tariff design.
However, utilities must be careful when designing tariffs. Typically, they rely on fixed charges or minimal bills to reduce the cost shift created by PV customers who don’t pay the full cost of electricity delivery. But a high fixed charge could make an off-grid solution more economical for some customers, which would be disastrous for the utility. (See “How to Avoid “Zombie” Grids in the Age of Solar Power,” BCG article, April 2016.)
Technical Integration. The technical issues involved in load balancing to match intermittent generation are complex. As renewable energy comes to exceed 30% of total generation, capital needs will increase dramatically so that peaking generation and demand response match the load profile throughout the day.
DER creates unique challenges for utilities when a large number of solar installations or other distributed resources are connected to a specific circuit or feeder. In these situations, investment may be needed to increase feeder capacity, and other measures may be necessary to ensure that the voltage and frequency are kept within acceptable ranges.
Process and Organization Changes. Utilities must address a variety of organizational and procedural issues. For example, in some areas with high concentrations of rooftop PV, there has been an influx of customers applying to manage their usage, such as through demand response or selling power back to the grid, which many utilities have dealt with inconsistently. Standardized procedures are needed to create a clear and fast process for customers.
DER affects executives in diverse functions, from grid operations to customer service. Given the compartmentalized structure of the typical utility, this can inhibit decision making and efforts to integrate DER. Utilities should therefore develop cross-functional teams or even revamp their traditional organizational structure.
Utilities of the future will have to develop a greater focus on their customers, products, and services. Those that cling to the status quo face a growing threat to the value of their business. Utilities must move from serving rate payers to delighting customers, reflecting three trends in the marketplace:
A customer-centric utility will look significantly different from the “customer conscious” utility of today. Customers will become clients rather than simply service takers, and utilities will have to position their brands in the marketplace so that they provide the functional and technical benefits demanded by customers. To do that, they must improve customer insight. A better understanding of customers’ needs and preferred channels (including digital) will help utilities refine their value proposition and deliver products and services tailored for each customer.
We have seen utilities experiment with a variety of options for new products and services. For example, many are targeting community solar farms, with a developer or utility building a larger-scale facility and either selling electricity from the solar farm at a differentiated rate or selling ownership interests in the solar farm itself—a kind of “solar condo.” In other cases, utilities are offering rate-based distributed-generation assets, or leases and financing for distributed-generation equipment through bill payments. Utilities might also invest in distributed-storage installations, which will improve power quality and reliability for commercial and industrial customers, and in virtual storage as a service for distributed-generation customers.
Other opportunities exist in energy efficiency and demand management services. In addition to services offered directly to residential and business customers, utilities can use data collected from the grid to offer new value-added services, including the tracking of PV production, to distributed-energy companies.
Our research shows that customers see utilities as the natural provider for services such as community solar, energy use information, electric-vehicle charging stations, and even rooftop solar. To develop an effective customer-centric model, utilities must build the right organization and culture. They must simplify common processes, shift to digital or automated customer service interactions, and expand value-added services to win and retain customers.
Electricity demand is inherently variable and uncertain, and utilities must deliver a load that fluctuates throughout the year and throughout each day. These seasonal and daily variations are largely predictable, and traditional generation assets can be dispatched according to their short-run marginal costs. However, renewables like wind and solar are highly intermittent generation sources, complicating the supply mix.
As renewables come to account for a larger portion of the energy portfolio, vertically integrated utilities need flexible generation with both a faster ramp rate (to ratchet up or down depending on demand) and lower turn-down, or minimum-generation, levels (for times when renewable generation is running at full tilt). Conventional base-load generation sources, such as nuclear and coal, have slow ramp rates and long cycle times, which erode their operational and maintenance efficiency over time. As variable generation from renewables increases, utilities will need to replace these conventional sources with flexible generation, such as combined-cycle natural gas plants and storage, which will require new types of contracts with independent power producers.
Planning for this transition will be difficult, especially for vertically integrated utilities. In areas where renewable use is expected to be high, utilities should begin early to set a target for generation assets. Then they can calculate the required investment and infrastructure for optimizing the supply side of the network. Hawaiian Electric, for example, took a blank-sheet approach to determine how to reach its target of a 100% renewable portfolio standard. (See “Delivering a More Affordable Clean Energy Future for Hawaii.”)
Hawaiian Electric Industries, which provides electricity to 95% of Hawaii’s 1.4 million residents, faced growing disruptive threats in the first decade of this century. Costly, oil-based generation accounted for about 70% of the total generating capacity, contributing to electricity rates that were three times the US mainland average. This and other factors, including generous state and federal tax credits and support for net energy metering, led to the aggressive marketing and rapid adoption of rooftop solar.
With distributed generation at 20 times the national average, Hawaiian Electric, with its small, independent island grids, had to contend with potential grid reliability issues, slow customer interconnections, and increasing concerns about inequality from net metering (as nonsolar customers came to bear a larger share of grid costs). Moreover, Hawaii’s diverse energy stakeholders had differing views on distributed generation and other clean-energy programs and policies. Recognizing these challenges, the Hawaii Public Utilities Commission ordered Hawaiian Electric to reevaluate its strategy and transform its business.
Crafting the Strategy. Hawaiian Electric started by articulating a vision to “empower customers and communities with affordable, reliable, clean energy” and “provide innovative energy leadership for Hawaii.” This helped in setting specific goals for achieving Hawaii’s 100% renewable portfolio standard by 2045, tripling distributed solar by 2030, and reducing customer bills while providing more products and services. To deliver on these commitments, senior company officials, starting with chief executive Alan Oshima, supported a company-wide transformation based on the five pillars of change:
Stakeholder Engagement. Company officials continue to meet with stake-holders on key issues to seek input and understanding for the proposed plans. The utility created a stakeholder map early in the transformation to maintain contact and collect feedback from all parties. Hawaiian Electric worked to be as inclusive as possible during the process, even inviting key stakeholders to internal meetings to develop the results.
People and Organization. A self-assessment of business capabilities revealed gaps that needed to be addressed in meeting future organizational requirements. Hawaiian Electric identified the need for greater customer focus and rigorous analytical skills to meet its goals. It undertook a major cultural initiative to align employees’ behavior with the utility’s vision.
Almost two years later, Hawaiian Electric has made material progress in addressing the technical and organizational challenges of a complicated transformation. Follow the journey at Hawaiian Electric.
Given the technology’s rapid evolution, utilities can no longer plan for a 40-year time frame, and they will have to adopt technology such as battery storage to help compensate for the intermittent nature of renewables.
To make the transformation of utilities commercially viable, not just infrastructure but also regulatory and market models must change. Financial measures such as simple rate-of-return on capital expenditures may not recognize the value created when a utility is offering a variety of new products and services as part of a customer-centric approach.
In many cases, regulators are leading the charge. In New York, for example, the Reforming the Energy Vision program will overhaul the entire electricity system and turn the distribution company into a “common carrier.” Anyone will be able to connect new generation and other kits to the grid, and the distribution company will be responsible for “activating” the market. The distribution company will move away from the traditional cost-of-service model to a performance-based plan, similar to the emerging RIIO system (revenue=incentives+innovation+outputs) in the UK. Many states in the US are pursuing more incremental regulatory reform.
Utilities are more integrated into the social fabric of their communities than many other industries, and social and government policy changes bring a greater risk of disruption beyond the industry itself. As they position themselves for the future, utilities must engage a wide variety of stakeholders and invite them to participate in the process. The first step is to develop a comprehensive list of stakeholders for each jurisdiction in which the utility operates. The list should include elected officials such as the governor, as well as state regulators, municipal authorities, and independent power producers. Utilities should also consider new stakeholders, such as solar installers and battery manufacturers. After identifying the most important issues and concerns for each, the utility can develop a heat map to set engagement priorities for each jurisdiction.
Successful transformations in any industry require significant changes to business and operating models, as well as new ways of thinking and working. As they rewire themselves for the future, utilities must address changes in capabilities, culture, and organizational structure. (See Exhibit 3.)
Capabilities. Companies often underestimate the difficulty of building new capabilities and consequently underinvest in them. A transformation cannot be approached as a one-off event, with the organization returning to business as usual once the transition is complete. Utilities must assess how their current capabilities mesh with their transformation goals.
While transformation strategies vary, the need to strengthen several key capabilities is common across the board. These include an understanding of customer needs, analytical skills to address the data deluge that comes with new technology, and commercial skills to deal with an increasingly competitive market.
Culture. A company’s culture is the set of values and behaviors that collectively define how actions support strategy. To create a high-performance culture, companies must answer four questions: What culture do we need? What culture do we have and why? What aspects of the organizational context should we change to get the behaviors we seek? How do we make the change happen? (See High-Performance Culture, BCG Focus, June 2013.) Utilities undergoing a transformation must change employee behavior to match the new strategy, which generally means shifting from a risk-averse, structured, command-and-control environment to one that is more dynamic, flexible, and accepting of calculated risks.
Organizational Structure. The organization’s structure must reflect the future needs of the utility. Traditionally, utilities were organized by functions that had existed for decades. As DER and other services that span these functions become more important to customers, utilities must consider structures that encourage collaboration. Speed and agility are essential if an organization is to respond to marketplace shifts, as are clear reporting lines, appropriate spans of control, and minimal organizational layers.
After a utility has identified the key elements of its transformation, it must consider how it will manage the tactical aspects of the change. It must establish the infrastructure needed to execute and oversee the transformation. Even the best transformation will fail unless the right people, processes, and attitudes are in place to support the plan through the transformation and beyond.
Company leaders must be engaged and supportive, because the effort will require significant resources from all of them. To manage and support the transformation, they should create a transformation management office (TMO) to provide project management and other logistical support. The TMO, which should report to the transformation’s leader, typically comprises the following:
Management should require a significant commitment of time from everyone involved, and the TMO should include people who can execute, tackle new problems, keep an open mind, and work across functions. (For more on how to structure a transformation, see A Leader’s Guide to “Always-On” Transformation, BCG Focus, November 2015, and The New CEO’s Guide to Transformation, BCG Focus, May 2015.)
Utilities face unprecedented demands from customers who expect more, from technology that is increasingly complex and flexible, from big data that is enabling novel business opportunities, and from infrastructure that desperately needs updating. Much has been written about the utility of the future, but change will come only when that knowledge is put into action.
Utilities must decide on the right strategic approach to tackle this new environment. Predicting what the market of the future will look like is one thing, but today’s utilities need a roadmap for getting there. The first steps will be difficult, but the results of a successful transformation will be celebrated by employees, customers, and shareholders alike for decades to come.