Can Current Utility Business Models Meet the 21st Century's Consumer Demands?
Electric utilities have had a good run for a century. They've provided safe, reliable (mostly), and affordable (mostly, thanks to government regulations) electricity to a captive audience in whatever city, county, or state they were serving.
Guess what? It's the 21st century. It's the 4th industrial revolution. It's a time when commerce has turned upside down, and the century-old business model for providing electrical service to customers meets its demise.
Existing electrical utilities still have a chance to survive the tsunami of change hammering their industry, but it's a small chance. New, agile players adopting an entirely different business model are likely to dethrone the kings in the coming years.
This post is the second part of a six-part blog series I'm offering to outline a business model that will disrupt the current system serving electric utility customers with the reliable, affordable, sustainable, clean and LOCAL energy that consumers demand in the 21st century. The first post provided an overview of why current utilities are not positioned to meet this need and how new players should be preparing to enter the game.
In this post, I'll explain why current business models (I would say "current and historical business models," but the current business models are already historical) and regulatory roadblocks make the change nearly impossible for existing utilities. Then I'll begin to touch on a new business model that entrepreneurs should adopt to disrupt the utility sector.
The Century-Old Electric Utility Business Model
For its time, it made sense. To build out a power grid to serve homes and businesses in a wide and disparate land was not going to be easy, and it was not going to be cheap. The idea of having competitors building out vast wire networks on top of each other also was ludicrous.
Industry and government came together and did what made sense. Where it was feasible, for-profit companies were given broad authority to build up a grid to serve customers in a reliable, safe, and profitable manner, with government regulation to protect consumers from a monopoly mindset. Where that wasn't possible, the government stepped in.
The approach left us with three kinds of players in the electric utility industry serving the vast majority of electric customers:
- Investor-Owned Utilities (IOUs): These are the for-profit businesses that serve mostly urban areas with the denser population and less need to string as many miles of wires. As the authors of a report published in 2018 by the Rocky Mountain Institute, the American Council for an Energy-Efficient Economy, and America's Power Plan pointed out, these companies make up only 6 percent of the utilities in the country but serve about 68 percent of the electric customers.
- Municipal Utilities (Munis): These city-owned utilities operate just like any other city service, such as water or trash collection. They generate revenue for the city, which often exceeds the cost of providing electrical service to the community — an issue I'll touch on later. Some 60 percent of utilities are munis, but they serve only around 15 percent of electrical customers.
- Cooperatives (Co-ops): These non-profit entities were created under the Rural Electrification Act to provide service to rural America. They are owned by the customers and managed by elected boards. Co-ops comprise 26 percent of utilities and serve only 13 percent or so of electric customers.
The Difference in Models and the Problems They Create
Each of these electric utility types operates under different business models with unique problems that block their way moving forward in the 21st century. I'll touch a bit on the issues of each one, but I'll focus more on the issues facing the giant IOUs.
Let's look at their business models and issues in reverse order:
Co-ops serve a sprawling base of customers (owners) and have a vast wire grid that must be served reliably. Bringing on new technology to serve that grid is problematic because the only revenue sources are customer payments and government loans. Rural areas seldom have the deep-pocket industrial customers that boost their bottom line or who are interested in investing in growth.
While co-ops have professional management staff, they are governed by elected members who may or may not know the electrical industry. A forward-thinking board might be willing to push for innovation, but a fiscally conservative board could hinder growth.
As many municipalities across the country are pushing toward more sustainable electric sources and reducing carbon footprints, these could be a good opportunity for innovation. Many municipalities also are joining forces in regional alliances to seek green energy sources.
Municipalities also operate a relatively tight grid, so technological updates on the grid could be more feasible.
One challenge for munis is cities often rely on excess income from the electric department to fund other portions of the city operations. This could hinder investment opportunities and discourage conservation efforts.
In granting monopoly rights for these businesses to build out the vast power grid, governments also established a system of regulatory controls to ensure the companies served their customers with reliable, safe, and affordable electricity.
A big consideration in this regulatory control was how the companies were allowed to establish rates to pay for their investment and earn a profit. Each state regulates utilities differently, but these rate cases are often based on a relatively short time frame, like one to three to five years.
This leads to rates being based largely on capital investments and growth. Companies build out their generating capacity, grow their customer base, and encourage increased use of electricity to generate more profit for their investors.
This creates two issues that will impede the industry moving into the 21st century:
- Rate-setters reward utilities for tying up their money in capital investments — meaning other innovations that would benefit consumers, the environment, and the industry are not funded. Utilities will need to invest in a ton of technology to ensure customers who want green energy are indeed being served green energy. These investments will have to be recognized by regulators before investors will be willing to make them.
- Companies that are rewarded by generating more electricity have no incentive to encourage customers to reduce electrical consumption. To satisfy investors, these companies need to maintain the growth portion of the business model that has served for a century. However, consumers are no longer playing along. From homeowners to giant businesses, consumers are taking the initiative to reduce electrical usage and minimize their carbon footprint. That leaves utilities fighting against their investors' interests and their customers' interests.
Building a Customer-Centric Business Model
This last point leads me to what I believe is the biggest challenge facing all three of these utility types and which creates the greatest hindrance for them moving forward.
The century-old business model for these utilities never focused on customer needs and desires. Therefore, they lack the culture that grows up around serving customer needs first. Changing the culture within a business or governmental entity is hard.
Hundreds of businesses, and even industries, have disappeared when they failed to recognize the changes their customers were adopting. Will this happen to electric utilities? I have my suspicions.
That's why I believe this is the time disruptors finally will be able to break into the electric sector.
Technological advances and customer demand have created the opportunity for local energy markets that adopt a customer-centric business model — which I'm calling Retail 2.0 — to carve out a profitable and energy-conscious sector of the market.
These companies will rely on sustainable, carbon-free energy sources in their regions to meet the demands of industrial and residential customers by leveraging technology and data to their advantage. Their founding will be in a customer-centric culture designed on a 21st-century model.
The energy industry has built out over a century, so don't expect the new market to dominate overnight. The plan I'll lay out over the next few blog posts will succeed where other disruptors have failed by adopting this localized approach that will allow companies to understand their customers' immediate needs best.
The model will be agile in approach to serve the broadest geographical, cultural, and state- or country-based regulatory demands. I'm also proposing a staged approach that can meet investors' needs for a quicker return as the company continues to grow and service an expanding customer base.
I hope the ideas I present through this blog series will spark your own thinking about our world's energy demands and how best to serve the 21st-century customers. I encourage you to share your ideas through the comment section or through my LinkedIn page.
The saying that"it takes a village to raise a child" also applies to creating innovative changes designed to meet our energy needs across regions and nations. We need to put our collective creative energies into these efforts to achieve long-term success.