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Take No Prisoneers? A Price-War Strategy for Electric Utilities

Fortnightly Magazine - July 1 1995

costs (em has been recognized for several years by the senior managers of investor-owned utilities (IOUs), as is evident in their continuous downsizing.

A look at deregulation's effects on the capital-intensive airline industry underscores this point. Like the state public utility commissions (PUCs), the Civil Aeronautics Board set fares that provided an allowed rate of return on rate-base investment. These fares offered airlines little incentive to hold down labor expenses, fight restrictive work rules, or otherwise operate efficiently. American Airlines, for example, was spending fully 38 cents out of every revenue dollar on labor.3 (U.S. electric and combination utilities typically pay 10 to 20 percent of revenues for labor.) After 1978, new carriers with nonunion workers enjoyed substantially lower-cost labor than the established airlines.

In a direct-access environment, IPPs will become the "Southwest Airlines" of the electric industry. Not only do IPPs have more efficient operations, but they are often exempt from taxes charged IOUs. IPPs in New Jersey, for example, are not required to pay the 13-percent gross receipts tax levied on the state's electric utilities. This underscores the importance of the industry's efforts to "get the rules right."

The second significant aspect of direct access is the relationship between customer retention and customer satisfaction. A 1992 survey of 15 electric and combination utilities by Reichman-Karten-Sword (RKS) found that one in three residential customers would switch electric suppliers for a 5-percent price reduction.4 (Stated loyalty rates are typically even lower for large institutional and industrial customers.) This helps explain why the market value of California's three biggest electric utilities plunged by $3.1 billion within the four weeks after the CPUC's retail wheeling proposal was announced.

But the RKS survey's most important finding was the link between customers' perceptions of performance and their loyalty to their current energy supplier. Specifically, only 20 percent of customers who considered the value of their electric service "excellent" claimed they would leave, as compared to a 40-percent defection rate for respondents who considered the value "pretty good."

As in the telecommunications industry, utility managers can literally save their company by increasing the proportion of delighted customers. To identify the main issues that provoke disloyalty in specific market segments, ask customers what types of service another supplier would have to provide to get them to switch.

In an industry in which customers will change suppliers as easily as they now change from AT&T to MCI, the quality of market share will be as important as the size of market share. The notion of market-share quality includes profitability related to customer loyalty. Specifically, a utility with a loyal customer base will not incur the marketing costs of attracting replacement customers nor the costs of setting up and closing accounts. The quality of market share will ultimately be a function of each electric supplier's ability to delight its customers.

Nevertheless, price is not always the reason a customer switches to a new supplier. Successful utilities will be able to de-commoditize their services for less price-sensitive segments. In the same way that Sunkist branded and differentiated a commodity product like