[BETA] Fortnightly

Learning from Wal-Mart.

It's bad enough that merchant generating companies are struggling under the weight of regulatory, accounting, and public scrutiny in an era of shattered shareholder confidence. To make things worse, over the past few years generation was overbuilt on speculation that sparks spreads would be maintained and the economy would grow. But sparks spreads have shrunk, and given the national economic downturn, energy use is also down. This comes at a time when generating companies are straddling the regulated and non-regulated worlds. Generating companies continue to have a tremendous amount of regulated governance-if not in reality, certainly in their struggle to discard a cost-of-service mentality. Realistically, these companies should be working within a commodity business model, but instead find themselves still operating like regulated entities in many of their business decisions. Most of these companies primarily make electricity-a commodity product (notwithstanding potential ancillary services). But most are not yet adept at driving down costs while building in efficiencies. Yet Wall Street, customers, regulators, and the public all expect generators to be competitive and to deliver solid business performance.

Moreover, even if assets are still regulated, companies find themselves subject to a rate freeze-either self-imposed or the result of a negotiated rate settlement. Or perhaps their public utility commission recognized the need to act as a substitute for an unregulated market. Whatever the origin, the drive to cut costs and live under rate caps is accelerating. Companies are faced with a new reality: To capture additional business value by optimizing all of their assets.

Identifying a Better Business Model

Taking all of this to heart, generating companies now recognize they are faced with some make-or-break decisions about how to create significant value from their assets-regulated and non-regulated-in order to satisfy all of their stakeholders. Defined in the simplest terms, they are looking for ways to make electricity at the service and quality level that customers expect, while also continually finding ways to reduce the incremental cost of production. Because they are now producing a true commodity, they will have to figure out how to maintain costs (or even lower them) while increasing operating flexibility and reliability to keep customers satisfied. In fact, generating companies would do well to become more like Wal-Mart-or Home Depot, Boeing, or McDonald's. Does that sound like a very big stretch? Probably. But Wal-Mart excels because it continually figures out how to improve efficiency and be more effective in running and stocking its stores, working with suppliers, and serving its customers. Wal-Mart doesn't gold-plate anything; it develops and operates facilities to sell products to specifically meet customers' needs. And it does that extremely well. In effect, Wal-Mart keeps growing because it knows how to optimize all of its assets while increasing customer satisfaction.

The successful business model for the generating business going forward is not very different from the model Wal-Mart uses. To satisfy all of their stakeholders, companies must learn how to:

• Optimize the production of a commodity, , increase capacity, commercial availability, and efficiency;
• Meet the service level and quality expectations of customers, , flexibility