Business model change
Expectations for disruption around business models appear to have slowed marginally in the utilities sectors, possibly as a result of business model changes since last year which have made them more resilient. Or, as the chief executives commenting on the results point out, the great white heat of technology in some sectors has not moved with the pace of change perhaps expected a year ago.
Asked whether they expected to change their business model in the next five years, CEOs scored an average of 6.3 as against last year’s score of 6.7. or the likelihood of business model change over the next 10 years, CEOs scored 7.7, as against last year’s 8.7.
And looking ahead over the next 15 years, this year’s score of was 8.8, was slightly down on last year’s 9.3.
Matthew Wright, managing director of Orsted, comments: “It’s difficult to predict the pace of change over the shorter time period because there are a great deal of unknowns in terms the development and deployment of technology – for instance, how quickly will electric vehicles come in, will the cost of battery energy storage continue to come down and how quickly will we move over from natural gas to hydrogen? People might disagree on the timescale of those specific things.
“But, it’s clear that the industry can see a fundamental change over the longer term – it’s not a case of whether but how quickly. Decarbonisation, decentralisation and digitalisation – these are all huge developments which are now unstoppable.
“In terms of the next five years, in terms of the EV industry and how we switch over to electric vehicles to in line with Government’s “road to zero” policy will need to be well planned and have an appropriate charging structure. There is a huge opportunity here if we do it in a properly planned way.”
Another CEO from the distribution side, who did not wish to be named, agrees the current pace of change has slowed. “Twelve months ago, there was lots of talk about decarbonisation of transport and decarbonisation of heat – but perhaps not as much has happened as might have been expected. Electric vehicles have started to move in the last 12 months, but storage and heat have not moved on at all. However, over the next 15 years, all these issues around heat and storage will have moved on considerably.”
Despite the slight decline since last year, it’s clear that business model change is something all CEOs see as necessary and inevitable in order to evolve and thrive, scoring the prospect 8.8 out of 10 over the next 15 years.
John Morea, CEO of SGN, commenting on business model changes, said: “One thing I’d expect to see in the coming years is the continuation of the convergence between electricity, heat and transport sectors and therefore the need for government to take a whole-systems approach to solving the challenge of decarbonisation.
“We’re already seeing this in transport with fleets in the ‘hard to electrify’ bus and HGV sector being converted to run on compressed natural gas (CNG), a cheaper and quieter alternative to diesel and one which supports both carbon reduction and delivering cleaner air in cities.
“We, and I’m sure this is the same for other gas distribution companies across the country, are seeing an increase in requests for peaking power generators to connect to our network. These provide resilience for the local electricity grid by generating electricity locally to meet peaks in demand. If our power, heat, transport and waste sectors are all interdependent, then I think so must be the solutions for their decarbonisation.” Morea agrees with other CEOs that technology and policy change will be the main drivers for successful business model transformation.
“I see innovation and new technology as key drivers for change in our industry. In RIIO-GD1, the innovation stimulus enabled us to develop pioneering keyhole and robotic techniques which dramatically reduced the time and disruption on our street works.
“I believe the continuation of a dedicated network innovation stimulus in RIIO-GD2 is key to build on the success of the innovation regimes in RIIO-GD1. To allow for the transformation needed to a lower carbon energy system while minimising costs and impacts on customers.”
He adds: “The key technology trends affecting our industry are IOT (internet of things), Artificial Intelligence (AI), digital disruption and cyber security. The advancement in remote, connected devices which offer the ability to collect vastly increased and improved data sources – so we can better manage and maintain our network – combined with the ability to utilise machine learning and AI to harvest and act on this data, all offer us genuinely transformational ways to manage and run a remote and highly distributed gas network.”
Morea says that new and increasing customer expectations are also driving change. “It means we all need to continually reassess how we engage with and exceed our customer expectations. We need to look at all forms of digital in order to move away from the old and traditional business models for our customer interactions and truly embrace digital. Underpinning these trends is the need to utilise significantly more computing capacity, but in a flexible and low-cost way. That’s why we’re progressing with the adoption of best-in-class public cloud services.”
Acknowledging security issues as a further driver of change, he says: “Energy resilience and availability of supply remains a huge priority for our industry, which is why in the management of critical national infrastructure, security is one of our highest priorities. The continued advancement and increasingly complex nature of cyber security risk across all industries but particularly within the utilities sector means, in order for us to continue to protect our customers’ energy supply, we’ll need to continually develop our skills and investment in technology to stay ahead in the cyber war.”
Looking at individual sectors, domestic water wholesalers are the most convinced of the need for business model change over the next five years (scoring 7 out of 10), closely followed by energy retailers (6.8), energy generators and power networks (both 6.6) and gas networks (6.4).
Commenting on the findings, Peter Emery, CEO of Electricity North West, suggests that the slight lessening in transformation urgency “could be very well be down to the fact that the CEOs from across the different sectors of utilities are at different positions in the price review timetable. Distribution network operators just had midpoint review – so face a relatively stable environment to 2023.”
Domestic water wholesalers are the most convinced they will need to change their business over the next 10 years (9.3) and 15 years (9.8).
Again, commenting on these findings, Colin Skellett, CEO of Wessex Water, says: “I think the retail side will change, given the politics. And I think we will see more offering of multi-utility retail services; new entrants such as M&S could become players.
“We’ve also seen proposals for more upstream competition from Ofwat, which is proposing competition in the bio-solids market.”
Skellett questions the shape of organisations going forward and the need for vertically integrated monopolies, where a water company builds, owns and operates the assets. “The same people don’t have to finance and operate – it can break down and that’s starting to happen.
“But we do need to see capital investment in a competitive market.” Thames Tideway, he says, is a model for this – a huge infrastructure project being financed and delivered in a different way – a model for the direct procurement of major capital projects being introduced under PR19.
In Skellett’s view, and our survey shows he’s not alone, “more and more regulation doesn’t work. What’s needed is more competition in the market, that’s what does more to drive innovation and competition.”
However, not all his peers share his view that more entrants will see the market as that attractive. Three-quarters of water wholesaler CEOs see no possibility of new entrants into the water market within the next 15 years.
The other 25 per cent believe new entrants will appear within the next 10-15 years.
If the market is opened up further, 50 per cent say it would have a negative effect on customers. The other 50 per cent say it would make no difference either way.
Successful business model transformation – and how it will be achieved
In the opinion of the surveyed CEOs, the two most important factors in successfully transforming business models over the coming years will be, firstly, adapting appropriately to changes in policy and regulations (7.9) and, secondly, investing significantly in technology (7.5), as well as also investing in ‘enterprise IT’.
Significant organisational restructuring will also be required (6.3), in addition to finding new sources of revenue (6.2).
Significantly, mergers and acquisitions are not seen as an essential part of future-proofing companies (4.8). No one is predicting more industry titans coming together following the path of the Npower-SSE merger.
However, Co-op Energy’s CEO David Bird, says he expects to see mergers at a lower level: “I think we will continue to see larger firms buying smaller ones, and also customers having to be switched to retailers of last resort, because it’s like a deck of cards and not everyone will survive.”
The fact that reality is beginning to bite, is reflected in the wider financial landscape. Compared to 2017, the sector acknowledges that it is marginally more difficult to raise both debt and equity – perhaps reflecting the honeymoon is slightly waning for challenger brands. Asked how easy it was in the current business environment to raise debt, CEOs marked this 6.3 (compared with 6.7 in 2017). Equity is harder to raise – with CEOs scoring this 5.5 out of 10 (compared with 5.9 in 2018).
Main challenges on the path to successful business model transformation
Politicians and regulators who don’t understand how utility companies operate are seen as the main barrier to successful new business models emerging (8.2).
There also are a number of other significant obstacles to future progress in companies’ evolution: cyber security (7.4), skills shortages (7.3), and failure to grasp the opportunities offered by advances in information technology (7.2).
Being unable to improve customer perceptions of utility companies is another potential problem that needs to be factored in (6.9), as does maintaining shareholder returns while delivering a business change programme.