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The $250 billion U.S. electric power industry is in the midst of historic transformation. The industry structure of the past — vertically integrated utilities operating in protected geographic markets — will soon go the way of the gas lamp. Participants in the future electric power marketplace will have more diverse corporate structures and product offerings. Some will operate in narrow niches, and others, across state and even national geographic boundaries. All will focus on specific areas of competence and, as a result, may be forced to invest in a narrow range of assets and earn a return for their investors in a broad range of ways.
In this article, we outline a new structure for the U.S. electric utility industry. We discuss the factors that will likely lead the industry to fragment into a wide range of service providers in an expanded business. These disparate segments will be linked to serve customers through three emerging types of “value networks” rather than through integrated providers. The first value network will be based on regulated boundaries. The second will be based on linkages created by “virtual” utilities — firms that supply energy services but no longer own all the assets necessary to supply these services. The third will be based on customer-initiated linkages. As a result of these three new networks, customers themselves will be able to assemble more easily a panoply of power services that best suit their unique needs.
Our purpose here is to paint a vision of the emerging future. Such predictions are always risky; nevertheless, articulating a vision helps shape the debate and therefore, indirectly, the evolution of the industry. Our vision is based on analogies drawn from other regulated and unregulated industries that have undergone similar dramatic changes. In addition, we extrapolate from current electricity industry initiatives that provide a glimpse into the future.1
First, we summarize the factors that are forcing a restructuring of the electric power business. Second, we make five projections about the industry’s future based on similar experiences in other industries. Third, we describe how the industry will evolve into six discrete business segments, from power generation to energy services. To dominate each segment, utilities will need different core capabilities and will have to learn or import them from industries where competition, powerful customers, and choice have prevailed for years.
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1. B. Mitchell and P. Spinney, “Public Utilities, Technological Change, and Industry Structure” (Saratoga Springs, New York: Symposium on the Virtual Utility, paper, April 1996).
Mitchell and Spinney highlight the benefits, as well as the limitations, of reasoning by analogy. They show areas in which there are close parallels yet sharp differences between deregulation in the telecommunications industry and the electric utility industry.
2. For detailed accounts of changes in the electric industry regulatory framework, see:
P. Navarro, “Electric Utilities: The Argument for Radical Deregulation,” Harvard Business Review, January–February 1996, pp. 112–125;
L. Hyman, America’s Electric Utilities: Past, Present and Future (Vienna, Virginia: Public Utilities Reports, 1994); and
R. Hirsh, “Consensus, Confrontation, and Control in the American Electric Utility System” (Saratoga Springs, New York: Symposium for the Virtual Utility, paper, April 1996).
3. For an illuminating account of regulatory changes and their consequences in the airline, banking, natural gas, and telecommunications industries, see:
R.H.K. Vietor, Contrived Competition (Cambridge, Massachusetts: Harvard University Press, 1994).
4. Navarro (1996).
5. “Cogeneration” is the coproduction of useful thermal energy (e.g., steam, hot water, or hot gases) and power (e.g., electrical or mechanical) from a single source.
6. Hyman (1994), p. 150.
7. Vietor (1994), p. 328.
8. Navarro (1996).
9. G. Simon, Cambridge Energy Research Associates, “The Lessons from California: Analyzing the Impact of Far-Reaching Utility Deregulation” (Georgetown, Washington, D.C.: CSC Senior Management Interchange on Business Reengineering: An Industry Perspective for Electric/Gas Utilities, presentation, 11 January 1995).
10. Navarro (1996).
12. For numerous examples of such impacts of technological shifts, see:
M. Tushman and P. Anderson, “Technological Discontinuities and Organizational Environments,” Administrative Science Quarterly, volume 31, September 1986, pp. 439–465; and
Mitchell and Spinney (1996).
13. Hyman (1994), p. 116.
14. K.E. Yeager, “Technology Triggering Structural Change,” Electrical Perspectives, volume 18, January–February 1994, p. 27.
15. Hyman (1994), p. 117.
16. R.E. Balzhiser, “Technology — It’s Only Begun to Make a Difference,” The Electricity Journal, volume 9, May 1996, p. 35.
17. T. Hoff and C. Herig, “Integrating Renewable Energy Technologies in the Electric Utility Industry: A Risk Management Approach” (Saratoga Springs, New York: Symposium on the Virtual Utility, paper, April 1996).
18. Hyman (1994); and
G.G. Wattley, “Where Technology Goes, So Goes Restructuring” (Washington, D.C.: The Energy Daily, 20th Annual Energy Daily Conference on “Breaking Up the Electric Utility Industry,” paper, 1–2 December 1994).
19. For a description of how the confluence of various new information technologies can transform consumer processes and alter existing industry structures, see:
R. Buday, N. Nohria, and J. Champy, “The Rise of the Electronic Community,” CSC Index Insights, Spring 1996.
20. For a discussion on the rise of new intermediaries on the Internet, see:
Buday et al. (1996).
21. Vietor (1994), pp. 319–322.
22. C.M. Studness, “Stranded What, Exactly?” Public Utilities Fortnightly, volume 132, 1 December 1994, pp. 40–42.
23. Surveys were conducted at CSC Index utility conferences, February and July 1995.
24. The authors are grateful to one of the reviewers of this article who correctly noted that, strictly speaking, the marginal price is not zero. Only intramarginal units of electricity are generated at close to a zero price, but at the margin, the cost is that of a combustion gas turbine. As this reviewer further noted, prices may fall even in the absence of restructuring due to the ending of a large number of PURPA contracts.
25. T.K. Smith, “Why Air Travel Doesn’t Work,” Fortune, 3 April 1995, p. 46.
26. Ibid., p. 43.
27. P. Ghemawat, “The U.S. Airline Industry in 1995” (Boston, Massachusetts: Harvard Business School, case 9-795-113, revised 7 October 1995).
28. Vietor (1994), p. 146.
29. Simon (1995);
E. O’Grady, “NYMEX: Electricity Contracts ‘Healthy’ as First Year Ends,” Dow Jones Telerate Energy Service, 27 March 1997; and CSC Index analysis.
30. “COB” and “Palo Verde” refer to two separate exchanges for electricity futures and options contracts, established by NYMEX. They were named after their respective delivery locations: one based on delivery at the California-Oregon border (COB) and the other at the Palo Verde switchyard in Arizona. Both sites are major market centers with easy access to the California market.
31. T. Noda, “The Evolution of the Baby Bells” (Boston: Massachusetts: Harvard Business School, working paper, 1996).
32. Forbes, 4 July 1994, p. 66; and
Wall Street Journal, 8 August 1995, p. B5.
33. A.F. Amey, “Complementary Forces: Information Systems Innovation and Competition in the Deregulated North American Gas Transportation Industry, 1970–2000” (Saratoga Springs, New York: Symposium on the Virtual Utility, paper, April 1996).
34. W. Emmons and M. Brand, “Note on Railroad and Trucking Regulation” (Boston, Massachusetts: Harvard Business School, Case 9-793-041, p. 14, revised 3 April 1994).
35. J. Sheth, “Global Competition and the Power of Three,” CSC Index Review, fourth quarter, 1996, pp. 13–16.
36. Studness (1994).
37. Evidence of this can be found in the natural gas industry, where the variable costs of the average gas pipeline today are lower than the lowest variable costs ten years ago. See:
CSC Index internal study, 1996.
38. FERC, through its Notice of Proposed Rulemaking (Docket No. RM95-8-000), the so-called “mega-NOPR.”
39. Newsbytes News Network, File n0704001.8, 3 July 1995.
40. PR Newswire, File p0626175.600, 26 June 1995.
41. Companies like Morgan Stanley, LG&E Energy, and Duke-Louis Dreyfus have obtained power marketer licenses.
42. Emmons and Brand (1994), p. 13.
43. Vietor (1994), p. 146.
44. F.W. McFarlan, D.G. Copeland, and C.L. Marshall, “Canadian Airlines: Reservations about Its Future (A)” (Boston, Massachusetts: Harvard Business School Case 9-195-101, revised 25 October 1995), p. 2; and
American Airlines, Annual Report, 1990.
It is estimated that in 1990, American’s reservation system, SABRE, had pretax profits of $150 million on revenue of $500 million. American Airlines as a whole, after backing out of SABRE, lost nearly $250 million on revenues of $10.5 billion.
45. N. Venkatraman and J. Michaud, research on value networks conducted by CSC Index’s Genesis research program, 1996.
For a more detailed discussion of the new roles in emerging value networks, see:
N. Venkatraman and J. Michaud, “New Roles in the Value Network”(Dallas, Texas: CSC Index Genesis meeting summary, “The Renewed Growth Agenda,” 7–8 February 1996), pp. 8–12.
46. The consumer products industry is a good example. Producers such as Dow-Corning or DuPont provide raw materials to manufacturers like S.C. Johnson, which provide products to retailers such as grocery chains, which in turn provide products to end consumers.
47. The emerging competitive market for electricity envisions that existing utility customers will be able to secure power from alternative suppliers. When this occurs, the utility that originally supplied power to the departing customer may not be in a position to market the power sold to the departing customer to an alternative customer. The utility thus suffers a potential financial loss due to structural changes in the industry, leading to the creation of what have commonly been called “stranded assets.” See:
“The Changing Structure of the Electric Power Industry” (Washington, D.C.: Energy Information Administration, DOE/EIA-0562, December 1996), p. 77, note 170.
48. A competitive transition charge is a non-bypassable fee to collect stranded costs.
49. The obligation of a utility to provide electric service to any customer who seeks that service and is willing to pay the rates set for that service. Traditionally, utilities have assumed the obligation to serve in return for an exclusive monopoly franchise.
50. For a discussion of how a virtual corporation links competencies that it may not own, see:
W. Davidow and M. Malone, The Virtual Corporation: Structuring and Revitalizing the Corporation for the 21st Century (New York: HarperCollins, 1993).
For similar ideas, see also:
N. Nohria and James D. Berkley, “The Virtual Organization,” in C. Heckscher and A. Donellon, eds., The Post-Bureaucratic Organization (Thousand Oaks, California: Sage Publications, 1994); and
H. Chesbrough and D. Teece, “When Is Virtual Virtuous?,” Harvard Business Review, volume 74, January–February 1996, pp. 65–74.
51. Dar also develops and subscribes to this idea. See:
V.K. Dar, “The Electric and Gas Industries Are Converging: What Does It Mean?,” Public Utilities Fortnightly, volume 133, 1 April 1995, pp. 21–26.