Utility Week reviews the findings from the first iteration of its new regular research series with industry chief executives. This third instalment of research analysis covers CEO views on radical changes to business models.

What’s in this report?

Utility Week’s new CEO Insight research series will provide regular access to the sentiment of industry chief executive on key themes and developments impacting the sector, and their businesses individually.

Our analysis of the findings from the first iteration of this research will be published in easy to digest installments, however, a complete research report will also be made available.

This installment of research analysis focuses on CEO expectations for business model transformation and the challenges involved in achieving successful outcomes, including:

  • Workforce talent challenges
  • Customer perceptions and satisfaction

Meanwhile, previous installments of research analysis covered CEO sentiment about the macro political and economic environment in which they are operating and CEO views on the regulatory regimes under which their organisations operate.

Future installments will cover access to finance and investor confidence

Executive Summary

As utilities grapple with the transformational change sweeping the sector, company chief executives face challenges on many fronts. In the first of a new, regular series of research reports – CEO Insight – Utility Week surveyed the leaders of the UK’s major utilities, to understand their views on the political and economic climate their organisations are operating in, the regulatory and policy landscape surrounding them and what the future holds in terms of change and challenge.

The results paint a picture of chief executives poised for sector disruption. They expect radical changes to business models, even in the short term; are dissatisfied with or lukewarm to the regulatory regimes they operate under and express concern in relation to wider economic and political factors impacting their businesses.

Key findings

Utility Week’s first CEO Insight research, conducted by Utility Week’s independent market research partner Insight Advantage, shows:

  1. Policy and regulatory instability are the highest rated factors impacting businesses today, receiving scores of 7.9 and 7.5 out of ten for impact respectively. The third highest rated impact factor was change and uncertainty relating to new technologies and commercial models (7.2).
  2. Brexit is currently relatively low on CEOs’ agendas, with respondents scoring its impact at just 4.5 out of a possible 10. However, this varies considerably by sector, with vertically integrated energy companies scoring it much higher than average (7 out of 10) and water retailers much lower (1.5 out of 10).
  3. More than half (57 per cent) of CEOs believe the regulatory regime under which they currently operate is not fit for purpose, with water retailers and challenger energy supply brands most likely to take this view, and power and gas networks least likely to. Even with water retailers and challenger suppliers taken out of the equation however, nearly half of CEOs say their current regulatory regime is not fit for purpose.
  4. Even in the next five years, CEOs expect considerable change in their business models, with respondents rating the expected scale of change at 6.7 out of ten in the next five years. This rises to 8.7 out of ten in the next ten years, and a transformational 9.3 out of 10 in the next 15 years.
  5. Respondents expressed a strong appetite for M&A, with 81 per cent of CEOs saying their organisation would be a “buyer” in an M&A scenario. At the same time though, there was little expectation of significant M&A activity in the next 12 months, with 67 per cent of CEOs saying they expect “very little” M&A and a further 19 per cent expecting “moderate” levels of M&A.

While responses to some questions show significant variation in opinion between different utilities subsectors, qualitative commentary on the survey findings, provided by sector leaders, showed the findings generally resonate with chief executives across the board.

Even in areas where a single subsector stands out from the crowd – for example with regards to networks’ support for their regulatory regime – qualified comments shows that there are significant and growing concerns about the direction of travel for the future, and the influence that political interventions are having on this.

In this first iteration of our CEO research, respondents from the water sector – spanning wholesale and water retail – provided especially robust responses to questions about satisfaction levels with the regulatory and market structures which envelope company operations and profitability.

To acknowledge this, as well as including observations on water responses in our general commentary, we have broken them out in a special subsector focus chapter.

The next iteration of our CEO Insight series will gather evidence over spring 2018, with a second report appearing in the summer.

Business model transformation

Overview

It is a well-documented and widely commented- on fact that the UK utilities industry is going through a significant period of disruption and transformation which is putting pressure on companies to embrace new technologies and new ways of working.

CEO responses to our survey show that is transformation challenge is now being actively tackled, rather than simply planned for.

Within the next five years, CEO expect considerable changes to manifest in the business with respondents rating the expected scale of change at 6.7 out of ten in this period. A complete transformation process for the industry is expected to be more drawn out however, with increasing levels of disruption to existing business models expect over a 10 and 15-year horizon.

As in many other areas, CEO expectations for business model change did vary by utility subsector, with challenger energy retail brands expecting the most disruption to business models in the nearer term. Water retailers expected the least change to business models in the next five years – which is unsurprising given the newness of the market and the fact that companies operating in this space have only recently established their business models.

Over a 15-year horizon however, water retailers expected almost total business model transformation, predicting 9.5 out of 10 for the scale of change. This may reflect expectations in the market that the domestic water sector will also eventually open to competition.

Overall, gas networks and water wholesalers expected the least radical changes to their business models over the next 15-years while challenger energy retailers, large vertically integrated energy companies and power networks all expected a 10 out of 10 total transformation of their business models over this timescale.

Commentators were unsurprised by the overall picture of CEO expectation for change. There was universal acknowledgement that trends for decentralisation, decarbonisation and digitisation have long been driving a need for change, and that these pressures are now converging and coming to a head.

Commentators from regulated utilities also expected business models to be transformed as a consequence of new commercial opportunities in markets which are currently undergoing reform or deregulation, such as bio-solids and resources for water and, potentially, the provision of flexibility services for energy networks.

Coop Energy chief executive David Bird told Utility Week he was “encouraged” that more and more utilities are now in the process of moving transformation plans into action via pilot schemes which put new technologies and commercial models to the test.

“It’s great to see different people in the sector trying different things to try and practically understand how some of the new business models that are being talked about might work in the future,” he said.

Speaking for his own organisation, he referenced a key trial in Bethesda in North Wales which is testing the workability of time of use tariffs linked to local sources of renewable generation. And over the next 10 years, Bird said he expected such experiments could well enable traditional unit pricing of energy to be overthrown and the dominant basis for billing customers.

“Once you have the data and understand customers better, the idea of offering customers energy contracts which are based on the maintenance of a certain level of comfort in their homes between months X and Y could work.”

Bird said this was because such models would play to suppliers’ successful track record in managing risk for consumers. “This is often forgotten,” he said. “We buy in the wholesale energy market and spread risk so that customers experience relatively little volatility in their prices. The service-based energy supply model is, to me, simply an extension of that absorption of risk on the behalf of the customer – but we need better data and analytics to enable it.”

Tackling the suggestion commonly made by technology analysts that utility business models, especially in energy supply, could be disrupted because global tech-giants like Google and Amazon will make them irrelevant, Bird said he was not convinced that this will be the case.

“Some of these organisations may well come into the market – but I think as partners. Energy is a complex market and we should not underplay the expertise that we have in UK utilities organisations.”

Bird concluded that it is more likely existing players will find opportunities to work a “coordinators” for the interests of big new market entrants, “rather than being kicked out of the market all together”.

Workforce challenges

Although CEOs expressed high hopes for business model transformation in the near and midterm future, it should be acknowledged that some significant barriers stand before the successful completion of this transformation journey.

According to our research, key challenges for utilities gravitate around recruiting and retaining skilled employees to support current and future operations. Commentary from sector leaders confirmed this view – though many CEOs were also confident that their approach to investing in apprenticeships and planning for changing skills needs will protect them from any risks associated with misalignment between workforce capability and organisational strategy.

Observing utility company CEO attitudes toward skills challenges, Energy and Utility Skills chief executive Nick Ellins said he was encouraged to see such high-level acknowledgement that attracting and retaining appropriately skilled staff fundamentally underpins the ability of businesses to achieve their goals.

Ellins also commended CEO commitment to supporting apprenticeships, and engagement with young people via partnerships with schools and other educational schemes designed to highlight utilities career opportunities.

However, Ellins warned that utilities leaders must keep a close focus on resilience strategies for attracting and retaining the directly and indirectly employed skilled workers, and not underestimate the challenge they will face from other sectors and infrastructure demands. “There is currently no coordinated UK approach to ensuring that the common competencies and skills needed to deliver multiple major upcoming infrastructure projects are in place and sustainable. It means the sector must act for itself and work as one”

“As the Hinkley Point C project swings into full force and HS2 kicks off in parallel with a gamut of other big schemes, there is a real danger that utilities will find themselves unable to maintain their supply of skilled contractors and the internal engineering resource they need to fulfil their own business plan commitments – especially if the uncertainty of Brexit does impact the UK’s ability to access European talent pools,” he said.

“Companies need to be sure they have a sustainable approach to protecting their workforce resilience and doubly check they are confident they can find the volume and quality of people they need under various scenarios.”

Other factors which could upset the effectiveness of utility skills strategies include fallout from the launch of the national apprenticeship levy which Ellins said is already having an impact on the way companies invest in training across the devolved UK nations, due to opposing skills strategies in the four nations governments and inconsistencies in the funding rules around the scheme.

With securing mass talent attraction, Ellins pointed to the Talent Source Network, which now has a database of over 3700 individuals with utilities-relevant skills, as a useful tool for utility-based businesses engaged in workforce resilience planning. He urged more companies to sign up to this and to the commitments of the utilities Procurement Skills Accord. Launched in late 2016, this scheme binds members to certain responsible procurement practices and asks them to cascade these to suppliers, with the aim of spreading skills resilience throughout the sector value chain.

Sector commenters recognised the need to remain alert to changing skills attraction and retention challenges. One senior leader at a gas distribution company said progress with HS2 and Hinkley Point C will “no doubt contribute to the increasing mobility of construction skills, the results of which we have already started to feel.”

Meanwhile, Electricity North West’s Peter Emery said that, while his organisation does not struggle to attract core STEM (science technology engineering and maths) skills for traditional roles, significant thought is currently going into strategies for building workforce capability in digital skills and commercial skills.

These skills areas have not historically been required to any great degree in networks companies, said Emery. But as digital technologies become pervasive, connecting consumer-grade and infrastructure assets via the internet of things, and DNOs move to realise the opportunities tied to DSO business models, the chief executive confirmed they will be in high demand.

Coop Energy’s David Bird had similar observations for the future skills needs of retailers, where he said the emphasis is shifting away from process, towards problem solving. The latter demands growth in empathetic skills which Bird said can only be achieved by increasing the diversity of talent in the utilities sector.

Consumer perceptions and satisfaction

One of the most pressing issues for any CEO is their business’s relationship with its customers – and this is particularly true for utilities at the present time.

With customer trust in utilities never far from the headlines, it comes as little surprise that a significant majority (62 per cent) of CEOs said they believe customer perceptions of utilities are becoming more negative.

Water wholesalers were particularly gloomy on this count, with 100 per cent of respondents from the subsector saying customer perceptions are deteriorating. This may well be a consequence of recent high profile political attacks on the water sector for being financially opaque and a manifesto pledge from Labour in the last general election to renationalise the industry. Such assaults have catapulted water companies from a position of relative anonymity into the centre of an intense public debate over the integrity and legitimacy of private utilities and would understandably contribute to a feeling that customer perceptions are worsening.

In commentary however, one DNO chief executive cautioned against confusing pollical hyperbole and media coverage with the day to day reality of customer experience.

“There is a question to be answered by the utilities industry about legitimacy,” he commented. “But this is more to do with pollical philosophy than customer experience. Customers don’t ask questions about legitimacy in our everyday conversations with them, they ask questions about service.”

And on the whole, the CEO continued, Ofgem measures show that satisfaction with network service is on the increase, with most DNOs now achieving rewards for outperformance against the Broad Measure for Customer Satisfaction.

Peers at other networks agreed there is a need to differentiate between perception, as it is reported in political rhetoric and mainstream media, and objective feedback captured in regulatory frameworks and independent measure like the UK Customer Satisfaction Index where some utilities stand out as top performers.

For example, in the latest iteration of the UKCSI, which is overseen by the Institute of Customer Service, Wales and West Utilities outperformed brands which are commonly recognised as cross sector exemplars for customer satisfaction, such as Amazon, John Lewis and Marks & Spencer.

Other commentators observed that declining customer confidence is not a unique challenge for utilities, but a macro-trend which transcends sectors. “Customers across the board are getting harder to keep happy,” said one. “And while customer service score might be going up overall, I think this is the result of laggards catching up, rather than continued improvement from service leaders.

“Generally, I think that the top performers for customer satisfaction are having to work harder and harder to stand still, but are not moving the frontier forward.”

Some chief executives were more optimistic however about the ability of utilities to exceed customer expectations and create positive perceptions around their brand, and the sector as a whole.

Matthew Wright, UK managing director for Orsted (formerly Dong Energy) observed that while a legitimacy issue certainly exists at the utilities-customer interface, evidenced by the move for price regulation and other market interventions, macro-trends surrounding the sector offer a great opportunity for positively transforming this relationship.

“More broadly, if you look at customer support for renewable energy – and in our case offshore wind, it’s enormously high,” he observed.

“I think it is wrong to say that customer perceptions of all aspects of utilities is poor – it depends what part of the value chain you are in. And there is a challenge, therefore, for CEOs across the sector to regain or to reinforce legitimacy by communicating a clear purpose for their organisation that customers can identify with.”

Orsted has invested an enormous amount of resource and effort into transforming its business to align with the purpose of decarbonisation and leadership in a clean energy future. The company has almost completed its divestment of fossil fuel-based business activities, in favour of a strong focus on offshore wind, other low carbon technologies and b2b energy retail – where the emphasis is on energy efficiency.

Wright concluded that CEOs who can align their business with a clean energy future – “which holds significant positive interest for consumers” – can create a positive customer perception of their brand.

While he admitted that this challenge is arguably harder for utilities which directly bill customers, because they need to prove value for money and meet customer experience demands, he observed: “Also arguably, there is huge opportunity at the customer interface. It might be harder, but the prize is bigger.”

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