In Norway and in England and Wales, power retailers are learning hard lessons.
The U.S. electric industry has long tried to follow Thomas Edison's dictum "to sell light instead of current" (em to get beyond the meter. But what is beyond the meter at industrial and commercial sites?
In energy-intensive industries one sees processes such as smelters, pulp mills, rolling mills, refineries and chemical plants. In general manufacturing, although some electricity is used for specialized electrotechnologies, most is used for lighting, motive power, computing and robotics. On commercial premises, electricity is mainly used for lighting, air conditioning, refrigeration and computing.
What is beyond the meter is diverse and characterized by a wide range of technologies and products. These products are manufactured and marketed in different ways with different skills, many of which are a far cry from the technical and commercial skills available in the electricity supply industry. Electricity industries in the U.S. and Europe have spent a lot of money trying to go beyond the meter. Based on the diversity of what is out there, it is not surprising that they have not established a significant foothold.
More recently, gas marketers have suggested that by analogy with their activities in the gas wholesale market, they can add value in the electricity market by services such as aggregation, fuel management services, asset optimization, reliability through diversity and risk-management services. But in reality, most of these services (with the notable exception of risk management) are for the wholesale market, rather than the general retail market. Furthermore, some only exist because of inefficiencies in the gas wholesale market.
Now various people are hoping that electricity is not a commodity, and that it can be sold as a value-added product. To be skeptical, if not cynical, some seem to hope to rise in the industry on marketing magic and get bigger budgets, and some consultants are peddling snake oil. Much of the muddle in the debate has arisen because the character of power retailing has not been understood. The meaning of value added has not been clear; and there has been no experience to draw on. But we now can get a reality check from markets in England and Wales and Norway.
Many of the marketing activities undertaken in other competitive markets either do not apply or, perhaps more importantly, cannot be applied cost effectively in power retailing to medium and large industrial and commercial customers. It is false to draw close analogies between competitive and noncompetitive markets. What is required is a "paradigm shift."
In the 1980s, the Electric Power Research Institute promoted the concept of integrated value-based planning to shift the focus from least-cost planning and apply text-book marketing concepts to "adding value." The report concluded:
Utilities need tools and methods to help identify how best to provide value to their customers in order to respond to competitive threats, and to take advantage of market opportunities. Utility customers do not purchase kilowatts and kilowatt-hours; rather they purchase the end uses of electricity. ... They value activities or work that can be accomplished with electricity. ... This suggests that utilities should examine (em and plan for (em product lines of service options that arise from those customer preferences.
Finally the report gave examples of value-added products and services under the headings: "Product-Related Risk Management," "Facility Operations Management," "Price-Related Risk Management," and "Customer Convenience."
An examination of these services in a competitive market shows that some are available automatically as part of an electricity market. Services such as reliability of supply are related more to the monopoly wires business than to competitive power retailing. Those items that were essentially subsidies were eliminated in a competitive market. A service such as advice is either expected as part of customer service, or is part of consultancy services that are financially insignificant compared with supplying electricity. Other services, such as comprehensible bills, are what customers expect from a competitive and competent supplier. If a power retailer makes it difficult to do business, then it will have few customers.
Integrated value-based planning was useful in helping with the slow process of refocusing the industry from production to a customer-orientated view. Most of the analogies drawn with other markets, however, were not relevant to the regulated monopoly environment in which electric companies operated. Many utility costs are scrambled together and smeared across the system. Prices can discriminate and cross subsidize. And political and regulatory management skills have been more important than commercial competence.
A Valid Example: Power Retailing
With the development of competitive electricity markets in England and Wales, which is a poolco system, and in Norway (and Sweden, see below), which is a bilateral trading system, we need to speculate no longer. Now we can examine how retailers and customers with a load of more than 100 kilowatts really behave when there is choice. In both countries, the electricity supply industry is unbundled into five components:
• a wholesale market;
• transmission (as a common carrier);
• distribution wires (as a common carrier); and
• power retailing.
The retailer pays for use of transmission and distribution networks, which are unbundled and provide nondiscriminatory common carriage services at regulated prices. In England and Wales, power retailing involves buying from the pool (through which all electricity traded wholesale flows) and hedging volatility with financial contracts for differences, and selling to end use customers. In Norway, power retailers can buy from generators and from a spot market at the margin. They can also buy futures contracts to manage risk. A key feature of both markets (as in other commodity markets) is that customers can access the pool or spot market. They can do this either directly by becoming a member of the respective markets, or indirectly by seeking a competitive agency service from a member.
Although the commercial trading relationships are different, the characteristics of power retailing are similar in both markets:
• The margin is slim (em it is like any other merchanting business with a large turnover, a slim gross margin and an even slimmer operating profit margin. In England and Wales, the gross margin supplying large customers is comparable to the margin in the wholesale gas marketing business in the United States of about 1 to 1.3 percent. The operating profit supplying all customers averaged 1.17 percent of sales income over the four years from 1990 to 1994, and most of that profit was made in the franchise part of the business. The margins are comparable in Norway.
• As in all commodity markets, expectations of the spot price drives the price of short-term contracts.
• A key factor for success in power retailing lies in coupling control of risk with contracts that offer pricing structures and price levels customers find attractive.
How Do Customers Buy?
We interviewed a cross-section of 10 medium-to-large industrial, commercial and other types of customers in both countries. A consistent pattern among the British and the more-aggressive Norwegian customers emerged in:
• buying electricity through some form of tender;
• choosing their power retailer(s) based on price; and
• regarding electricity as a commodity.
In both countries, most customers buy in a sophisticated manner that enables them to fine-tune their plants against the spot market. Several buyers in Norway bought for reasons other than price. A major manufacturer of power equipment, for example, bought on strategic grounds, because electric companies are its best customers. A municipality bought from its own electric undertaking; and there was pressure on a supermarket chain to buy from a local electric company.
The customers were asked whether they were interested in buying the following services from power retailers: electrical contracting; power quality advice or solutions, or both; advice on efficiency of usage; shared energy savings schemes; and other technical assistance. With one exception, the largest industrial users of electricity had little or no interest in buying these services from power retailers per se. They believed either that they possessed the necessary technical skills and financial resources or could get the services more cheaply.
Several commercial customers in England and Wales were interested in using the distributors' electrical contracting businesses. Some sought advice on power quality. Others showed interest in shared energy savings schemes. Other commercial customers said they look for nothing more than electricity supply from power retailers. Apart from expecting advice on energy efficiency, which the electric companies must provide, Norwegian customers generally expected little from the much smaller utilities in the country.
One limitation of the survey reported here is that, except for a few cases, the customers interviewed were all large and sophisticated. In England and Wales, however, a number of smaller customers buy through agents. Some of these agents purchase for several customers, and their behavior appears to be similar to that of the larger, more sophisticated customers.
Another limitation of the survey is that it did not include a sample of customers in Sweden, where the market was liberalized for large customers on Jan. 1, 1996. The Swedish electric companies have a tradition of providing services for larger customers and claim success. It is, however, too early to tell whether it will prevail over the Norwegian approach of regarding electricity as a commodity and going for lowest price.
What Do Power Retailers Think?
A consensus has emerged among power retailers in England and Wales that little hope remains for selling value-added services to industrial customers. Some typical quotes are:
• "Among the medium size and larger customers there is no loyalty. Sales are purely on price; a customer will change supplier for $50."
• "What a corporate customer wants is a long-term relationship with a supplier with whom he feels comfortable that he is not being taken to the cleaners. ... Value added is only realized if the service offering has a quantifiable value."
• "Customers are not looking for such services, and will not pay for them. One does not buy insurance from an insurance company because it offers additional services. Larger customers are only interested in price. McDonalds, [which] for example, operates to the last half-cent, treats electricity as a commodity."
• "The only service customers notice is bad service; good service is expected and taken for granted." Although price will determine most negotiating situations, past good service will "get the last shout."
What Will Work?
Looking now at the various meanings of value added, what is the reality behind the hype?
Offering customers tangible economic advantages. Two types of value added could prove relevant in power retailing:
• Risk management may be useful for large, energy-intensive customers who want to hedge the risks of their electricity purchases against prices in their sales market. The net-back contract for an aluminum smelter is the classic example.
• Leasing and flexible payment terms are of value to some customers.
Guiding customer decision making. There is scope for guiding some customers towards innovative pricing structures. For example, in 1991 and 1992, Midlands Electricity successfully persuaded many customers with consumption in excess of 1 MW to buy at pool prices, plus an adder.
Selling profit enhancement and problem solutions. Some companies are trying to link sales of electricity into a package such as shared-savings energy schemes or undertaking electricity works in a new factory or building. Opportunities to gain a percentage point or two on price have emerged.
Providing psychological benefits to customers. The following three examples may help to a limited degree in selling electricity and are definitely helpful in selling complementary services for additional income:
• Brand image. Electricity companies normally have a reputation (em some good, some not so good (em in their traditional service territories. Those with a name that is an asset (em perhaps they are regarded as established, reliable and competent (em can capitalize on their reputations and, with care and patience, extend it outside their territory. For example, Midlands Electricity established Powerline as a brand name for its tele-selling operation in England and Wales. In the U.S., UtiliCorp United was doing the same with its branded EnergyOne electricity, before it spun off the brand as an independent business with AT&T and PECO Energy as franchisees.
• Bundling prices. Often the purpose of bundling prices is to obscure the cost base and to make it more difficult to compare prices. Bundling is frequently linked with innovative and changing products.
• Relationship marketing. Buyers often prefer to do business with people they like and who look after them. In such cases, the buyers will overlook a slightly higher price to avoid the bother of changing retailers. PowerGen has put considerable effort into this approach, and claims to retain about 85 percent of its customers.
Caring for customers. Particularly for large customers and smaller, profitable customers, care is fundamental to success. Customers expect to be treated with consideration. If they are not, then they will walk away. The hotel that first put a mint on a pillow must have gained customers; polite airlines are preferred to discourteous ones; contracts that are in plain English and bills that are comprehensible must add a little value, and so on.
Developing complementary services. There is some scope to get beyond the meter, most notably in: wiring up factories and office buildings; taking over distribution networks; offering shared energy savings schemes and cogeneration systems for industrial and commercial customers; and power protection equipment. But apart from taking over large distribution networks (e.g., major airports), buildings and large cogenerators, the money is small compared with electricity to an integrated utility. The sums are, however, significant to a power retailer.
Value added is supplier-related not product-related. Customers know there is no difference in the product, but they may see a difference in the supplier. The value added lies in the service. If a company is trying to "brand," it is the service, not the product that should be branded. Consequently, the marketing lessons for industrial and commercial customers lie not in product marketing, but in services marketing where new products can be rapidly copied and products have a short shelf life; the name of the game is devising new ones.
Electric companies should view value added more in terms of winning market share and volume for a commodity, rather than in gaining a significant price advantage. To gain 1 percent is quite an achievement in competitive power retailing. These conclusions may not be exciting, but they are realistic and focus on the fact that for medium to large commercial and industrial customers, electricity is a commodity. The ball game for residential customers, however, will play out on another pitch. The question will be: Who has the competitive advantage (em electric companies, credit card companies, supermarkets or others? t
This article is based on a report prepared for EPRI titled, "Is There Value in Value-Added Services? Evidence from Competitive Markets in England and Wales and Norway," TR-106195 Research Project 2343-19, Final Report, February 1996. Alex Henney is principal of Competitive Electric Strategies Inc., which is a joint venture between EEE Limited of London and Resource Dynamics Corp. of Vienna, Va. Jeff Percival was marketing director of Midlands Electricity and Ken Simmonds is professor of marketing at the London Business School.
The Meanings of Value Added
To a marketer, value added comprises the nonprice attributes that a customer takes into account in choosing to buy a product or service from one supplier rather than another. With common products, the marketer aims to find ways of pricing above a commodity price; or at the very least, to persuade customers to buy his commodity rather than hers. Although whole texts have been written on the theory and measurement of customer value, the term value added has been used with a wide variety of meanings, some of which are more precise than others:
• Offering customers tangible economic benefits, such as offsetting market inefficiencies and risk management;
• Guiding customers' decisions by, for example, reducing decision-making costs by offering data, calculations, measurements and surveys;
• Selling profit-enhancement and problem solutions. AT&T developed tele-selling by explaining its advantages and showing customers how to do it;
• Providing psychological benefits to customers, notably developing brand images, bundling or unbundling products and prices, innovating and changing products and relationship marketing; and
• Developing complementary services to distinguish similar products and enhance the basic product. For example, in the telecommunications field, companies with wholesale transmission now offer voice mail, call forwarding and waiting, teleconferencing, etc., all of which help to sell transmission. In most definitions of value added, the aim is to increase the bundled price of a particular product. With complementary services, however, the aim is to sell additional products and services to gain revenue from the basic product. Some complementary services grow so attractive to both the customer and supplier that the basic service is sold at a discount to support it (e.g., computers have been sold cheaply to sell software and maintenance contracts).
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