Analysts: Down on utilities. Is the party over? That’s the tough question posed in a research note by Wachovia equity research analyst Samuel Brothwell.
Marketing & Competing
specific functions with other utilities. This approach presents an alternative to wholesale mergers and may be especially appropriate for functions that will require new investment in assets such as software or communications networks that are highly leverageable across volume scale. There is danger, however, that the pooled entity will simply serve a larger protected market, yielding the benefits associated with greater scale, but not those that can only come from competition.
s Take equity in return for contracts. Utilities can take advantage of the fact that many companies, including existing vendors to the industry, will want to enter the new service businesses. By being an early outsourcer, a utility could extract equity ownership in the new business, in return for helping its partner establish a market presence. An advantage of this approach is that the utility can choose to align itself with companies likely to be the strongest competitors. One disadvantage: The partnering company will likely only give up a small equity share.
Participating in the "virtualization" of the industry is not incompatible with outright mergers with other distribution utilities. A company with functional businesses that serve other distribution franchises would be well positioned to gain from a potential acquisition (em it would have the experience to know what operational efficiencies and contractual profits it could bring. Conversely, generators seeking to acquire local distribution franchises as outlets for their power need no longer be as concerned about how best to achieve operational efficiencies in distribution operations; their third-party services suppliers will be pleased to provide competitive solutions.
The virtual path may not appeal to everyone, but there will be pressures to take it. Current vendors of hardware or technology will need to assess the likely pace of market evolution for specific services, their own willingness to take on some of the responsibility for assuring local electric or gas service reliability, and how to approach long-time customers (em who may themselves become competitors. If they choose not to participate in the new service businesses, they may face increased buyer concentration from their customers who do, with resulting pressures on prices and profit margins.
Regulators who have balked at performance-based regulation in the past may also be uneasy about the diffusion of responsibility for network reliability or consumer satisfaction that might accompany the virtual utility. The U.K.'s Regulator has overcome this objection by instituting uniform national service standards for all electric distribution franchises. It is unclear whether state commissions in the United States will be willing to set similar standards.
Utilities considering whether to take their own capabilities to market will need to weigh the potential for new revenue and profit against the risks and costs of dramatic organizational and structural change and of outright failure. Alternatively, they could also become virtual utilities without competing in the emerging distribution businesses; the other players would be happy to have them as customers. t
Corey Stone is vice president and managing director in the Stamford, CT, office of Easton Consultants, a management consulting firm.
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