The Innovation Imperative

Deck: 

Adaptive companies stand the greatest chance for success.

Fortnightly Magazine - November 2008

The IBM Institute for Business Value recently completed its biennial Global CEO Study, in which over 1,100 CEOs were interviewed in person about their views on changes in customer attitudes, business models, and the globalization of business. Based on these interviews, which spanned 40 nations and 32 industries, IBM compiled a comprehensive report, The Enterprise of the Future, which describes traits that the leading companies across all industries will share. Key industries—including utilities—also were evaluated individually to see how these traits might emerge as industries reshape and evolve in the face of customer demands, environmental pressures, global integration, workforce changes, and other challenges. Meeting these forces becomes even more challenging as executives sort out the current crisis impacting the global financial markets.

In many respects, utility CEOs expressed opinions on the future that were very similar to their peers across industries. Seventy to 80 percent of the CEO pool in general, and utility CEOs specifically, stated that they were bracing for substantial changes over the next three years.1 These numbers significantly werehigher than those from two years earlier.2 The emergence of more informed and collaborative consumers in particular is seen as a key change and a likely driver of new business; almost 70 percent of utility leaders see this new type of customer ultimately having a positive impact on the business. But in other areas, the CEO study results pointed out some of the challenges that utility executives face that differ in scope or intensity than those of many other industries.

Coping With Uncertainty

When asked to point to the external factors most likely to affect their business in the next three years, utility executives were almost five times as likely to include environmental issues on the list as did the average CEO (see Figure 1). While the focus on environmental issues (particularly climate change) has increased across all industries, it is interesting to note that this ratio is almost exactly the same as it was in the 2006 version of the CEO Study—the industry clearly has maintained its leadership on recognizing and addressing the impact of its operations on the environment.

Sustaining this leadership position does not come easily, however. While utilities have been trailblazers in environmental stewardship on many fronts, there remains relentless uncertainty around the evolving nature of new carbon regulations, costs, and markets. This elevated level of scrutiny likely will transfer to all of the other corporate social responsibility (CSR) issues of concern to stakeholders as well.

Utilities’ relative positions on globalization versus the other industries is in some sense the opposite. Less than 30 percent of utility executives expressed views consistent with a globally optimized or networked business; almost two-thirds of their counterparts have such a view. The largest percentage by far felt that regulations were the biggest barrier hindering utilities from taking advantage of globalization opportunities. Unfortunately, utility CEOs can influence these to only a limited degree, leaving those who would like to make bolder strides toward becoming truly globally integrated enterprises feeling a bit boxed in.

Looking across the years rather than industries, the study found utility CEOs are less confident in their companies’ ability to manage a more rapid pace of change than in 2006. Looking at just the elements of the study mentioned above (i.e., consumers, CSR, globalization), the lower confidence is understandable—an honest CEO will not predict sure success for the company in a game in which the rules have not yet been written fully. For example, having established a history of environmental leadership, utilities increasingly will be pressured to solicit and address customer concerns on the wider spectrum of CSR issues, and raise the performance bar across all of them. Emerging global expectations and new rules in these areas will force the industry to address a disproportionate quantity of emerging questions and take bigger risks than most other industries. Similarly, when utility CEOs see globalization taking hold in all of their business touch points—with customers, suppliers, innovation, and, increasingly, regulations and some competitors—frustration is natural when significant barriers prevent them from doing the same.

How can confidence be restored? The results of the CEO Study, combined with research over the past two years, suggest that a renewed focus on innovation in utility business models will play an important role in clarifying the path forward.

Leadership Opportunities

The rapid pace of technological improvements across all industries is driving companies to consider changing their business models. The foundation work in basic research, design, engineering, and technology development phases might take years or decades, but once these advances are positioned to generate commercially-viable innovations, trial applications or deployments will move forward. These trials will allow the industry (or some relevant subset) and its customers to assess and quantify the benefits of new technologies. This will lead to an early round of new businesses that quickly will separate winners from laggards.

If this sounds familiar, it should—it is exactly where the utility industry stands today with a huge number of emerging technologies across the value chain, from distributed and dispersed generation through grid automation and analytics and into home and business applications. But utilities’ own self-reporting in the CEO Study revealed that they are about half as likely as the average across all industries to have focused on revenue or enterprise-model revitalization to adapt to the changes now underway.

Because the pace of the initial deployment and new business formation is an order of magnitude faster than the research and development phase, those who can most quickly and creatively adapt existing business models—or create entirely new ones—will take the lion’s share of benefit of this renewed growth (see Figure 2).

When new business models evolve out of these technological leaps, utilities will find the greatest value in taking a rigorous analytical view of changes underway, evaluating a range of change scenarios and pathways, and balancing costs and opportunities of various business model alternatives. Indeed, doing so might become a survival skill.

Sometimes, as innovations mature into more common business practices and lead to new opportunities in other industries, broader changes occur in the structure of businesses and in society—at the local, national, and global levels. For existing industry participants, individually or in industry subgroups, failing to navigate these periods of adjustment can lead to corporate decline or even extinction. To see how powerful this cycle is over time, consider that fewer than one in six companies listed on the S&P 500 index five decades ago remains there today. Even companies whose demise at the time might have been unthinkable, such as Pan Am and Bethlehem Steel, have been innovated out of existence.3

The transitions themselves require a strong focus on innovative business models. The current state of the industry can be described as “passive persistence,” in which traditional market structures dominate, and consumers either accept or prefer the traditional supplier-user relationship.4 As customers demand more control over their energy choices, and technologies proliferate that allow them to seize that control, utilities likely will follow one of two paths to move to a future state where customers and providers interact over a two-way, information-rich participatory network.

In one path, if customers are slow to embrace more control, or if regulatory structures are not in place to give it to them, companies that deploy technology for performance and cost improvements will transition through innovations in enterprise models. The primary focus will be on leveraging assets, technologies, and core competencies of the company, often through collaboration or partnerships. Such alliances will be especially valuable where proof-of-concept or proof-of-benefit trials are needed.

Conversely, if customers demand control more quickly than technology can be deployed (or regulators permit), companies will require substantial innovation in how they earn revenues. The wide variety of new technologies ready for deployment—smart meters, home automation, self-generation and the like—lend themselves readily to new offering combinations, and the historically static tariff structure of the industry in many parts of the world leaves a door wide open to more effective pricing archetypes.

Utilities will need to analyze how they can best reconfigure offerings and introduce new pricing models to meet shifting demands from more broadly differentiated customer bases. Some recent trials have demonstrated positive results in this regard. For example, a smart-energy pricing pilot in Ontario last year showed decreases in energy consumption and costs for consumers in the trial, and shifted peak consumption noticeably.5 But this type of benefit would not roll out in the same way in other geographies; different business models might lead to better results, depending on the desires of all stakeholders. A structured, fact-based evaluation of whether the utility is best served by changes in revenue models or enterprise models—or even in leading major innovation in or across the industry value chain—will determine how utilities and consumers can maximize and share in new benefits with the lowest risk and transitional pain of all of the potential options.

The industry’s evolution toward a participatory network will follow one of these paths because regulatory barriers, technology evolution, or the speed with which customers elect to take more control will make one path a more logical first move than the other. However, some of the early movers toward advanced network structures—particularly in locations with favorable regulatory structures, such as Australia and the UK—might serve as true business model innovators, in accordance with the timing and level of success of their actions in taking full advantage of the emerging participatory network.

Alternatively, it may be newer industry players who define the shape of things to come in partnership with (or perhaps at the expense of) existing industry participants. This level of innovation in business models—and those who dare to accept the challenge—will create the industry of the future and its next generation of leaders.

 

Endnotes:

1. IBM Global CEO Study 2008.

2. IBM Global CEO Study 2006.

3. Giesen, E, S. Berman, R. Bell, and A. Blitz, Paths to success: Three ways to innovate your business model, IBM Institute for Business Value, 2007.

4. Valocchi, M., A. Schurr, J. Juliano, and E. Nelson, Plugging in the consumer: Innovating utility business models for the future, IBM Institute for Business Value, 2007.

5. Ontario Energy Board Smart Price Pilot Final Report, Ontario Energy Board, July, 2007.