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Regulated Utilities: Reinventing the Classic Business Strategy

Opportunities and limitations of five top strategies.

Fortnightly Magazine - December 2005

customer side of the meter. (This assumes that the market territory includes the utility franchise area. When this type of service is offered outside of the utility franchise area it is considered a move toward related diversification.) A typical investment for a distribution gas or electric utility of this type would be a move into the heating, ventilating, and air conditioning (HVAC) services or construction business. A number of state regulators have imposed “royalty” payments for the use of the utility’s “goodwill” in this kind of investment, and at least one state has issued an order prohibiting the utility from offering these competitive services in its own service territory.

These actions also raise the question of whether the regulator will move to capture actual or even imputed efficiencies (beyond the issue of royalties) in any upstream or downstream investment for the customers. The authority for regulatory action will come from the regulator’s well-established track record and legal authority under “affiliated interest” laws and rules. Some of these laws require significant intrusion into these relationships to include pre-approval of contracts and prices for services provided by the affiliate.

Thus, a move upstream or downstream by the regulated utility may involve questions about the desirability of acquiring a business under an additional regulatory authority. This option also raises questions as to whether the move is superior to the continuation of outsourcing the service, possibly with a new and more efficient provider. Finally, any move by the regulated utility to invest in a business where the utility itself may be the upstream or downstream customer could trigger the full authority of the utility’s regulator under “affiliate interest” laws and regulations.

Synergy: The Holy Grail of Mergers

Mark Sirower defines synergy as “increases in competitiveness and resulting cash flows beyond what the two companies are expected to accomplish independently.” 3 These expectations of “synergy creation” lead to many mergers and acquisitions. However, he and many other analysts report that few mergers or acquisitions “create” value; more often, they destroy it. Nevertheless, new acquisitions and mergers continue to be announced.

Acknowledging that few mergers are truly “mergers of equals” and that almost every merger is an acquisition with an “acquirer” and a “target,” Peter Drucker, ever the realist, adds, “Acquisitions should be successful, but few are.” 4

The general procedure in a merger is that the respective CEOs meet to discuss the proposal, reach an agreement and finally gain approval from their boards and shareholders. The discussion between the two CEOs primarily is about how the benefits of the merger will be shared between the two companies. Both hope to gain benefits not otherwise available alone. Warren Buffet characterizes this stage as that of a “princess” paying for the right “to kiss the toad” in the hope it will become a handsome prince. 5 If the acquirer pays beyond what is reasonable for this right, the future is set up for failure if expected benefits (synergies) are not experienced. This sequence is followed by all mergers.

Regulated utilities face the additional barriers (sometimes multiple and usually contentious)