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Electric Retailing: When Will I See Profits?

Deregulation Abroad: Still Reaching Its Potential
Fortnightly Magazine - June 1 2000

product differentiators as well. New product features, bundled in innovative ways and sold to customers through creative marketing efforts and new channels, offer real opportunities for aggressive energy marketers. Given the proper environment and options, customers do switch in large numbers. Absent the right environment and attractive offers, they switch in very small numbers. That is the untold story behind the headlines.

In the nascent world of retail energy services, firms have engaged in aggressive business strategies to capture market share. Price wars are common, with most firms offering electricity at a discount off the wholesale exchange price. The only flexibility in such a pricing formula is the amount of this discount. There is neither customer segmentation nor product differentiation. The only product is commodity energy.

This strategy is murder on the bottom line. In California's first year of retail choice, one of the market leaders, New Energy Ventures, lost $22 million. PG&E Energy Services, another market leader, lost $50 million. Enron Energy Services, the national leader, lost $100 million. EPRI estimates that the whole industry lost nearly half a billion dollars. These losses continued in the second year of operations.

PG&E Energy Services recently announced a third year loss of $98 million. Bob Glynn, CEO of the parent PG&E Corp., plans to sell off the energy services subsidiary. He presented his rationale in purely financial terms: "We said from the start we would support operations in 1997, 1998, and 1999, but we needed to see it in the black" by December 1999. 17

As expected, such poor financial performance by ESPs has resulted in their consolidation. California began with 300 providers and two years later was down to 10. A leading national player, Duke Solutions, plans to exit the retail business altogether.

Business failures, like military failures, are caused by one of three reasons:

  • Failure to anticipate the behavior of key market participants, i.e., customers and competitors;
  • Failure to adapt to change; or
  • Failure to learn from mistakes.

In the emergent retail market, incumbents as well as new entrants eagerly committed all three types of failures, with attendant impacts on the wealth of their shareholders. Some suppliers were smarter than others, and cut their losses by exiting markets in which profits could not be earned, by developing new products and services, or by selling themselves off to other aspirants.

What's Next: Differentiation Will Increase Margins

As Winston Churchill noted in 1945, "The future, though imminent, is obscure." It is difficult to predict how future retail markets will evolve in the United States and elsewhere. There is insufficient history from which to derive lessons. Management authority Peter Drucker suggests that when dealing with discontinuities such as those posed by electricity deregulation, players focus on predetermining events that virtually always contain within themselves the seeds of the future. 18

In the British market, now in its second decade of competition, ESPs already are using price risk management services to differentiate their product offerings to large customers. Risk management products, based on modern finance theory, shield customers from unwanted risk. Empirical research has found