Rebranding Electricity

The utility industry has been virtually stagnant when it comes to introducing new products.  Many say electricity is the ultimate commodity – true. One cannot distinguish whether an electron was produced from a clean source like solar or a dirty source like a super polluting coal boiler, or an internal combustion engine or from a clean but potentially risky nuclear power plant.  So for many, the end product does not lend much variation for companies to play and win on differentiation and uniqueness.  As such the competitive forces have converged on the economics of production. Metrics such as levelized cost of electricity have been introduced to normalize comparison across the various technologies to get to apples to apples comparison, but it has limited use. Consumers don’t care much on the difference (or, very few do) and are more concerned about the reliability, safety and affordability of electricity.  But does this mean there is no possibility for differentiation? If water can be sold in bottles that compete with the faucet, then can electricity do the same?

Perhaps we need to start looking at other commodities to get some insights on consumer behavior.  Take for example, chicken or beef. Granted there are some variations with chicken and electricity. But these are commodities. When we go to a grocery store there are many kinds of chicken and beef.  Free-range chicken and hormone free beef typically costs more.  This provides some interesting cues to the way consumers care for what they buy.  This allows companies to target the segment aptly.  There are certain customers that care for how the product is made and not just the end product in itself. The how lends to the larger health issue.

Can this be relevant to electricity?  Electricity that comes from clean sources may be better for you than the electricity that comes from dirty sources. Not because of the electron per se but how they were made.  However, there is one fundamental difference between food and electricity production. Food directly has an impact on our body and what I eat has a more direct connection to my immediate well being than electricity.  At least that’s what I am led to believe. Same with water. With the recent crisis in Flint, Michigan, such scenarios are quite clear even in a developed country. Water may have another dimension. Consumers may trust a big company for quality related to health rather than expecting every water fountain to guarantee safety and quality.  The environment may be a close parallel with electricity.  We can hold someone responsible for the quality of air we breathe, and conversely we can seek a premium for better quality air. But we are not there yet. Generational impacts are longer time impacts that hit our psyche slowly.  For some it hits only after an adverse event.  For example, I find it a lot harder to resist food that is a slow acting time bomb on the body.  Foods that affect my cholesterol and heart, for example, compared to something that can cause immediate salmonella.

What does this tell us?

It tells us that consumer behavior, which like human behavior has something to do with the traits that we have never grown out of. Remember the famous Stanford marshmallow test.  Unless we have an adult posture that can put aside instant gratification for future joy, there is not much hope. All the concerns for global warming and willing to pay a price today for future benefit have a timeframe that is outside our concern. But that’s not the case for our future generation. And there may be immediate impacts that we are not smart enough to measure or notice.  That would be the starting point of creating something unique for branding electricity.  Just as we did with smoking by creating social awareness and banning smoking in public places, using clean energy needs to be drawn from a public health standpoint. It is going to be a long ride, but an important one.

 

Disruption – Over-used? What about “stack fallacy”?

Clay Christensen is the person behind making “disruption” a common term in business.  Lately he has been critical on how the term has been used for so many business changes. He has been critical on how everyone has been loosening its tie to the fundamental theory he proposed several years ago. In the December 2015 HBR issue, he elaborates and reminds everyone in this article.  Yet when I read this article on stack fallacy in the WSJ with its headline using disruption, I wonder whether the title “Why-big companies keep getting disrupted?” is appropriate.  Indeed, the article even has Christensen’s picture, leading the reader to believe that the WSJ author is paying an implied salutation to his theory. Not really.  This article depicts disruption as something more commonly observed with companies who drift down the stack. Companies that are built on top of underlying abstractions are better off in extending their product and offering boundaries. For example, Salesforce.com is a more successful CRM player because it understands the user better than Oracle, because Salesforce is higher in the application stack built on top of Oracle.  Oracle, in contrast is a database provider and the user base of the CRM is not the same as the user base of databases. The stack fallacy says it is easier for Salesforce.com to get into the successful database businesss than Oracle getting into a successful CRM business. Another advantage for flowing down the vertical integration is given that Salesforce.com uses Oracle databases – it is a customer itself – so it already knows the key customer needs.  Not the same with Oracle – hence it is much harder for Oracle to be in the application business such as CRM.  The facts prove this thesis.  This is an astute observation and the article refers to this article  on “stack fallacy”.  It is quite an interesting read – so highly recommend it. By this token, Tesla is more likely to be successful in making batteries than Panasonic in making cars.  (Aside: While going through the comments – I also came another read on what specialization does).

Going back to the central point – I thought disruption meant coming from the low end of the market and gradually seeping into the target customers of the incumbents – to a point when customers switch en-masse.  This is not because incumbents are stupid or negligent but because they don’t believe that they are in the business in which the emerging companies are good at.  They also beleive that the emerging companies are not good enough for the incumbent’s customer base.  That happened with PCs and mainframes, digital cameras with film cameras, and then phone cameras with digital cameras.  But then this is not the same as “stack fallacy” discussed in the WSJ article.  Many would even argue that the theory of disruption itself has limited practical use. It is a beautiful theory to explain the past but what about its predictive ability. How do companies know that they will get disrupted?  That exercise falls on the basics of strategic analysis and indeed, what economics have dealt for a long time in demand estimation – role of substitutes.  If there is a viable substitute then, losing market share for the incumbent is inevitable.  Hence, if the word “disruption” is only meant for a specific trajectory – the path taken rather than the state itself, then the theory of disruption ends up more of an academic distinction. If we focus more on the state of customer switching and the drivers of losing one’s business then the topics can be subsumed within the long-standing Porter’s 5 forces framework on competitive strategy. Why need another theory?

I lean more on the latter.  Just a few principles should be enough to explain most things.  MMarkets and customers are in flux.  Their preferences and choices are dynamic and shift all the time, getting shaped by all sorts of things. Knowing them and serving them right is the key challenge all businesses have and those that do better win. The stack fallacy is an elegant way to explain but I would reserve how far I go to explain everything.

Germany’s electricity situation

From the American utility industry vantage point, the German electricity sector appears to be in turmoil. The energy transition known as energiewende brought about a series of changes – some intended and some a bit more than that. The impact of these changes are quite widespread raising debates and questions on both sides of the Atlantic.  Renewables proponents showcase Germany as the poster child of what policies should be.  Traditional utilities tout that the right policy is exactly opposite of what Germany did.  Indeed, many believe good intentions gone bad.  Here are the key issues:

First, the phasing out of nuclear power by 2022. Germany has currently 9 nuclear reactors that generates about 15% of total electricity. After the Fukushima disaster Germany created a mandate to phase out all nuclear generation by the year 2022. Is this the right move? Is this an overreaction? Without securing backup generation, this is certainly turning out to be a hasty commitment that has become a political hot potato – too hot to touch anymore.

Second, the introduction and then proliferation of the Feed in Tariffs (FiT). Many countries have granted subsidies in various forms – FiT, tax credits, government grants, etc. to support the growth in solar PV. The way German FiT policies work is it requires transmission companies to buy solar PV at wholesale rates and then sell it to the retail customers. Assuming solar PV generated power in more expensive, the PV owner is made whole by a Feed in Tarriff that are ultimately paid for by the retail customers. Thankfully, the industrial customers are exempted which kept the energy prices for the Germany industry competitive with rest of the world. Has Germany gone too far? Does this create market distortions that ultimately result in inefficiency? Will solar PV become economical going forward?

Third, unprecedented growth in Solar PV driven by plummeting prices and favorable policies. Prices have fallen by 75% since 2006. With FiT and tremendous government push there is a growth in renewables. Solar PV is already reaching 6% of total energy consumption which may not look high but quite high by global standards. Is this sustainable?

The impacts so far have been quite pronounced with noteworthy the future implications in the electricity sector.

First the positive. The big governmental push has helped the solar PV penetration and its ride down the cost curve. Solar PV has become economically competitive and a viable alternative in certain parts of the world with certain limitations. On the other hand, German utilities are certainly the bearing the biggest brunt. The so called big-four utilities – E.On, RWE, Vattenfall and enBW are all struggling due to reduction in production and fall in wholesale prices. However, customers are facing high retail prices despite low wholesale prices, due to recovery of FiT susbsidies. FiT’s initial estimate was $3-4 B but due to the rapid rise in deployments that number has escalated to about $10B annually and likely to remain that until 2020. Another issue is the slowdown in carbon emissions market that has resulted in a growth in lignite based generation to cover for baseload power reduction largely due to reduction in nuclear generation. The low costs of carbon emissions (~$10/ton)  do not curb polluting behavior, which requires at least $30/ton by typical estimates. Lignite based generation – which is by far one of the dirtiest forms of coal for atmospheric emissions – will likely stay unless the carbon markets become material again.  Indeed, lignite generation, has an uptick not just in Germany – but also in neighboring countries from Poland to Czech and Bulgaria. All have plans to build lignite plants, absent higher carbon pricing.

Is it misplaced policy or a series of masterful political maneuvers to keep the constituents happy? Lot of theories are floating around. Promotion of renewables but passing the costs onto the customers is clearly not always apparent. Placing the death knell on the nuclear industry and pandering to the public fear and outcry after Fukushima disaster. No doubt, the issues sound simple, but it is quite complex. Time will tell how the transition finally gets implemented and received, and we all get to witness the full spectrum of intended and unintended consequences.