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Regulated Utilities: Reinventing the Classic Business Strategy

Opportunities and limitations of five top strategies.

Fortnightly Magazine - December 2005

wholesale electric market and a much larger than expected “windfall profits” tax as a new Labor government came to power and fulfilled one of its campaign pledges.

Thus, both U.S. and UK firms believed they had “core competencies” and “managerial advantages” in their acquisitions across international borders. In both cases, it was recognized that the ability to manage under regulation was the most critical “core competency” for successful management. U.S. firms entering England believed that their experience operating investor-owned utilities under public service commission (PSC) regulation in the United States would be a managerial advantage in the UK. The UK firms believed that their advantage in their more recent experience was purchasing in wholesale power markets and managing retail operations under “price caps” and “incentive rates.” In both cases management learned a tough lesson.

Professor Aneel G. Karnani observed that “to succeed at globalization, a company should balance global leverage with local adaptation.” Reflecting on Karnani’s advice, the case for any significant “global leverage” (in the sense of lower manufacturing costs) for a network-based utility is problematic. The ability of utility management to “adapt” to local conditions is critical. The primary local “condition” of concern here is that of “regulation.” In this case, “regulation” refers to the entire governmental scheme, including the executive, legislative, and administrative branches of government.

The key question for considering “globalization” as a strategy for a company operating in the regulated utility industry has to be whether management from country “A” can successfully develop the new “core competency” to manage under the full regulatory scheme in country “B”?

Market Penetration: How to Sell More Product

For the non-utility, increasing market share seems the most likely of approaches to increasing long-term profitability. Among techniques frequently implemented for increasing market share are new product innovations, finding new market niches, consolidating the industry, and creating entirely new ways of doing business. Karnani writes that market share can be increased when a company invents “a new way of doing business, a new business model.”

Electric and gas distribution utilities have little access to most of these techniques due to a combination of franchised service territory, regulatory constraints on service quality, and capital expenditure approvals (or pre-approvals) for any new investment. Public utilities also operate under the condition that state regulators set their prices.

In some states the initiative to restructure the electric industry into components of separated electric power generation, transmission and distribution came from utility management and has the potential to establish a new business model. This type of restructuring involves a form of regulatory arbitrage. This is explained as power plants in state rate base (state public service commission-regulated as to profitability) becoming subject to U.S. FERC regulation when they are sold. The ability to obtain FERC-approved “market-based” pricing provides, under the right conditions, an opportunity to earn a higher return for better operating performance than continuation under state regulation.

The “market share” approach of “new market niches” has some direct validity in the case of distribution gas utilities in areas where fuel oil is a major competitor for space