New realities demand new direction from utilities.
To paraphrase Shakespeare, "The true soul of joy is in the process." For the utility industry, nothing could be further from the truth. The deregulatory "process" has not been joyful. It has been painful and costly. Perhaps equally disturbing, the process has compromised the reliability of the utility industry and has placed in question the judgment of its leadership, all of which is particularly troubling for an industry where "reliability" and "trusted leadership" have been widely regarded as the industry's hallmark characteristics.
Although operating reserve margins were once an indicator of reliability, undercapitalized entrepreneurs now frequently own generating capacity. The industry's transmission system, which has always been an invisible, dependable network of arteries for reliable supply, now experiences blockages and hemorrhages symptomatic of bigger problems facing us tomorrow. Where stable dividends were reflections of trusted leadership, bankruptcy and restructuring concerns now overshadow the public confidence. The failures have been well documented: California, recent blackouts, Enron, PG&E, AES, Mirant, and LG&E Trading. The list goes on and on.
These changes prompt one to wonder what happened to our leadership. We cannot minimize the incredible structural changes that have occurred in the utility field since 1992. The traditional vertically integrated structure of 1992 was dismantled in large measure by regulatory design. But the reformatting of the industry also was accelerated and thrown off course as entrepreneurs of every form descended with visions of fast money. They came with trading schemes for marketing and sales schemes for aggregating customers. They also came with leveraged financing schemes for locating generating assets almost anywhere a pipeline and a transmission line intersected.
The leadership also participated in what had to appear as a random shuffling of industry business segments as mergers took place, unregulated subsidiaries sprouted, and utility holding companies came back into vogue. Did they join in a popular trend? They did. The truth is they had little choice. Their traditional industry and customer base were being cannibalized and, rightly or wrongly, participation in the trend was a form of self-defense.
The failure of the merchant generation business in 2001 was merely the latest in a series of failed business strategies by the industry since 1993. As shown in Figure 1, by 1992, most utilities were integrated utility systems. Earnings were stable and reliable. With wholesale power deregulation followed by retail choice, many utilities were forced to divest assets in many states and develop new business paradigms. Between 1993 and 2001, utilities tried a number of growth strategies, ranging from: (a) consolidation, through mergers and acquisitions; (b) diversification into cable, telecommunications, water, merchant power, and engineering services; (c) regional trading; and (d) divestiture and reaggregation.
The few success stories during this period centered on claims of avoiding major mistakes and not in celebrating returns of a scaleable and sustainable business model.
Sustaining valuation during this period, in and of itself, was a major task. Figure 2 offers a selective but instructive snapshot of a troubled period where volatile earnings and stock valuations prevailed. Yet, during this period, some utilities maintained a recipe for stability and appeared to execute prudent corporate strategies that allowed for stable value (Southern, Exelon, Dominion, and Con Ed), while others such as PG&E, Allegheny, Dynegy, and AES, to mention only a few, faltered. The dichotomy of performance during this period raises questions of both strategic conduct and also of leadership.
During this period, executives from outside the utility industry replaced a number of CEOs. The prevailing view was that utility deregulation required leadership that was accustomed to the competitive environment. The rush to outside "experts" proved flawed. These outsiders were more accustomed to a non-utility environment and failed to be respectful of the utility segment's roots and core strengths: (a) its commitment to serve its regulated customers; (b) its expectation of stable earnings; and (c) the importance of working with, and not circumventing, the regulatory process.
In Jim Collin's Good to Great, he notes that one of the most damaging trends in recent history is the tendency (especially by boards of directors) to select dazzling, celebrity leaders and to de-select potential outstanding leaders from within. Collins identifies companies that had cumulative returns at least three times the market over a 15-year period.1 Of those select companies, only one sought a CEO from the outside. Many of the characteristics Jim Collins attributes to outstanding leadership are strikingly similar characteristics to what we now view as the former utility CEO.
Those selected as the "Best of the Best" CEOs by in 2003 did not include a single CEO who came from outside the industry. Allen Franklin of Southern Co. was previously president and CEO of Georgia Power and Southern Co. Services. John Rowe of Exelon was previously president and CEO of Unicom Corp., Commonwealth Edison, and Central Maine Power. Thomas Capps of Dominion Power was previously counsel to CP&L and Boston Edison, and he then joined Virginia Power. Linn Draper of AEP was previously chairman of Gulf States Utilities. Eugene McGrath of Con Ed worked his way up the ladder internally. Each had firm roots in the regulated utility industry. It should not go unnoticed that these executives also match those utilities listed in Figure 2 as having achieved stable market valuations during perhaps the most volatile period in the industry.
Each CEO adopted a philosophy built around its core businesses, but the market structure is changing again and presenting new challenges to industry leaders. Further consolidation will occur, and ISOs and RTOs will characterize our markets. Transmission companies will prevail, FERC's standard market design will materialize in some form, and spot market transparency will happen as "day-ahead" and "hour-ahead" price discovery features prevail.
This time around, the electric utility industry is moving toward a formula that holds promise. Many in the industry are adopting a "back-to-basics" strategy for prudent long-term growth.
The new utility model for leadership:
- displays a workmanlike diligence, or is "more plow horse than show horse";
- is not hesitant to restore strong fiscal management; and
- demands implementation of a business model founded primarily on earnings from the utility practice and augmented by earnings from non-regulated business ventures.
It will be the only way to realize anything close to a Shakespearian experience.
- Collins picked three times the market because it exceeds the performance of most widely acknowledged great companies. For perspective, a mutual fund of the following "marquis set" of companies beat the market by only 2.5 times over the years 1985 to 2000: 3M,Boeing, Coca-Cola, GE, Hewlett-Packard, Intel, Johnson &Johnson, Merck, Motorola, Pepsi, Procter & Gamble, Wal-Mart, and Walt Disney. Not a bad set to beat as Mr. Collins points out.
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