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Four Paths to Prosperity: Growth Opportunities for Utilities
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Four Paths to Prosperity: Growth Opportunities for Utilities

How can utilities capitalize on burgeoning opportunities and determine a strategy that benefits both company and customer?

Today’s customers are increasingly interested in new energy choices that give them greater control, comfort, and convenience. Forward-thinking companies, like Amazon and Apple, are changing what customers expect from their service providers, including utilities. Increasingly, customers expect a menu of options that they can customize to meet their energy preferences, whether those are focused on controlling energy costs, improving the comfort of their homes and businesses, promoting environmental stewardship, or other interests. In a world of growing options and market actors, there is the potential for heightened customer confusion and inertia as decisions get more complex and require greater time and resources to vet.

As customers start asking, “Who can I trust?” utilities can become a beacon in a crowded marketplace, strengthening customer trust and loyalty. As that trusted advisor, utilities are well-positioned to be the preferred provider of new products and services, which can lead to new revenue and earnings opportunities. 

But how can utilities capitalize on these burgeoning opportunities and—more importantly—determine a path forward that benefits both company and customer? For a given utility, the answer to that question depends on a number of factors, including the utility’s strategic priorities, regulatory environment, customer base, and existing capabilities. We’ve identified four pathways for growing revenue through the provision of new customer offerings.

Charting Paths Forward 

Four paths are available for utilities to grow and potentially diversify revenue sources through new products and service offerings. The graphic below outlines the basic (and potentially complementary) paths and provides example product and service options for each. The relative revenue potential of these opportunities depends on a number of factors, including market demographics, regulatory treatment, and capital availability. In general, the highest potential options in the short-term are scalable programs that increase revenue without requiring major capital outlays.

Exhibit 1 chart showing details on Growing Sales, Growing Rate Base,Value-added services, and New Lines of Business

Increasing Sales

Electrification is the key to increasing sales. Termed “beneficial electrification,” these programs promote the use of electrically-powered equipment over fossil-fueled equipment across a variety of applications, and can result in improved local air quality, reduced greenhouse gas emissions, and customer cost savings. Electrification programs may utilize excess capacity, improve utility load factor, and increase the sales base over which fixed costs are spread, thus benefiting all customers. Program participants may also benefit from increased productivity, reduced energy costs, and cleaner work environments. Further, as the larger energy supply shifts to low and no carbon resources, the environmental benefits of electrification increase. Utility electrification programs have progressed well beyond the pilot stage, producing a program model proven across a number of long-running utility programs.

As an example, ICF has implemented CenterPoint Energy’s forklift electrification program in Houston, Texas since 2008. The CenterPoint program, which is largely driven through forklift dealer engagement and training, results in an average of 3.7 MW in load growth per year. Electrification programs are evaluated based on load growth delivered, incremental operating margin, and return on investment (ROI). Load growth and operating margin are highly variable based on the size of the program, but ROI is very favorable due to the long life of the installed equipment.

Electric light-duty vehicles (EV) also represent a significant potential source of new electricity sales in the long term. A typical EV traveling 12,000 miles per year uses approximately 3,000 kWh/year depending on the size of the vehicle. Utilities are actively promoting EVs through marketing activities, such as ride and drive events, employee engagement through workplace charging initiatives, rebates for charging equipment and, in partnership with automakers, vehicle rebate programs.

Despite their considerable benefits—increased energy security, better fuel economy, lower fuel costs, and lower emissions—EVs and similar technologies aren’t yet widespread, in part because publicly accessible charging infrastructure is limited. For this reason, utilities are also supporting increased availability of charging equipment at workplaces, retail centers, and public venues. Nationally, the federal government is establishing a network of charging infrastructure along highway systems. The auto industry is also working to expand adoption rates. Electrify America, a venture stemming from the Volkswagen Clean Air Act civil settlement, will invest $2 billion over the next 10 years in Zero Emission Vehicle (ZEV) infrastructure and public education programs. Collectively, these initiatives will increase the availability of charging stations which will, in turn, increase acceptance of EVs as a viable transportation choice.

Those implementing beneficial electrification programs must consider promotional practice rules, cost recovery of program expenses, and treatment of incremental sales margins, including where there are decoupling mechanisms in place. For example, utilities aren’t generally permitted to recover costs to advertise or promote electric use, particularly in cases of fuel switching. The most common exceptions to this rule are customer education and participation in energy efficiency or demand management programs.

We’re beginning to see utilities in progressive jurisdictions recovering costs for promotion of electrotechnologies where they have been shown to provide environmental benefits and meet cost-effectiveness tests such as the Rate Impact Measure test. Where a state’s DSM rules define energy efficiency and conservation in a way that is incompatible with electrification, electrification programs are typically paid out of operating expense budgets and can be funded below the line. 

Growing Rate Base

One of the primary ways utilities create shareholder value is by investing in assets and increasing the rate base on which they earn their authorized return. New customer offerings that allow utilities to own program assets, such as a community solar array or distributed energy resources (DER) offered as part of a customer program, provide an opportunity to grow rate base and increase earnings. This is likely a greater opportunity for vertically integrated utilities, as they typically face fewer restrictions on asset ownership compared to utilities in states with retail competition, where there may be rules prohibiting utility ownership of generation assets and/or prohibiting utility ownership of assets behind the customer’s meter.

Where not prohibited, the potential advantages of including distributed generation and other DER must be balanced against the potential for anti-competitive behavior that will limit market growth, slow innovation, and disadvantage other competitors. Local market conditions impact the potential risk of competitive issues, especially areas with existing broad and robust competitive markets. Policy considerations may come into play, too. For example, states with aggressive renewable energy goals or other policy mandates may leave all options for increasing renewable energy adoption on the table, including utility ownership where it serves the public interest.

Exhibit 2 for Four Paths to Prosperity blog article

Utility Ownership in Perspective — SoCal Gas

Working with SoCalGas, ICF completed a market study to examine the CHP technical potential of over 10,000 sites within the SoCalGas service territory. The study helped SoCalGas develop an innovative business strategy to offer enhanced CHP services to customers, including the option of having SoCalGas build, own, and operate CHP equipment on a customer’s site. To support this business approach, SoCalGas requested (and received approval of) a new tariff to offer CHP as a service to an individual customer with the CHP investment added to SoCalGas’ rate base.

While the business case for CHP is more straightforward for gas utilities, which will sell more gas, it also represents an opportunity for electric utilities. In many states, electric utilities can treat CHP investments as rate-based supply assets, the same as any other supply-side investment. With utility ownership of a CHP asset, the utility earns on the invested capital and continues to serve the full customer electric load, without the loss of revenue that occurs when a customer invests in CHP.

Investing in assets that enable new options for customers can benefit all parties, including currently underserved populations. Third parties can benefit as well when the utility serves as a market catalyst and/or relies on third-party installers to implement the program. Despite regulatory and policy hurdles, there are circumstances that may support utility ownership, too. Some include:

  • Limited/no market development 
  • Low consumer awareness and acceptance 
  • Opportunity to target low-income communities 
  • Access to lower cost capital 
  • Ability to leverage existing utility property and/or infrastructure 
  • Ambitious energy policy goals 

Expanding Value-Added Services

Value-added services are specialized services provided to customers and/or third parties in exchange for a fee, revenue sharing mechanism, or other financial benefit. Here, we focus on services that are an extension of a utility’s regulated operations and are provided through the regulated business, though offering the service through a separate, unregulated entity may be preferred depending on the utility’s particular situation and priorities. Often, value-added services leverage existing marketing channels and related IT systems and back-office support to effectively target customers and streamline the utility’s service offering.

These same resources can be used to provide value-added services to third parties, who can use this data to inform their business strategy and reduce customer acquisition costs. Beyond data, utilities can leverage their experience designing and installing electric infrastructure to provide turnkey projects, such as installation of CHP or microgrids at customer sites to improve reliability. Other examples of utility product and service strategies:

Next-Level Personalization with Smart Homes

ICF is working with utilities to introduce new offerings based on the installation of smart home devices connected to a universal app that provides automation, energy monitoring, preventive maintenance, and protection alerts. The app becomes a new channel for utilities to reach customers and leverage insights to provide a richer and more personalized customer experience and potentially increase energy and demand savings captured through the DSM portfolio. These programs are typically easy to scale and can generate revenue for utilities through equipment margin, monthly fees, and referral fees. 

Online Marketplace 

With 8 out of 10 Americans now shopping online, online marketplaces are gaining in popularity as a vehicle to add to revenue and provide another touchpoint to build engagement, satisfaction, and trust along a customer’s energy journey. Most utility marketplaces start with lighting catalogs (think specialty light bulbs) and online fulfillment. And though there have been advancements, the market has characteristics of still being in the early stages, including a rather fragmented and complex vendor landscape comprising different providers, different fulfillment vendors, different software platforms, etc. White Paper 

Additionally, most of the products available through marketplaces are limited to incentivized energy management products. Long-term, we expect that the expanding marketplace will act as a centralized hub that serves a wide variety of product and service needs for customers. This, in turn, can also increase the revenue generated through the marketplace. 

Existing online marketplaces vary in their scale and scope. One of the largest marketplaces is ComEd, which sells lighting products, smart thermostats, and other connected home devices. The site applies instant, point-of-purchase rebates, offers integrated customer support, and end-to-end fulfillment, including free shipping on qualifying orders. During a Black Friday and Cyber Monday promotion in 2016, thousands of customers visited the site, resulting in nearly $1.3 million in sales volume.

Connected Home 

The growth of the smart home market provides an opportunity for utilities to generate new revenue streams by offering customers home automation and related services.

Deciding whether to offer a value-added service through the regulated business or an unregulated subsidiary depends on a number of factors, including strategic priorities, risk tolerance, regulatory policy, legal considerations, and stakeholder input. When these programs are implemented through the regulated utility, the regulatory treatment must be addressed. For example, regulators must determine what portion of the net revenue can be retained by the utility as a contribution to earnings—depending on the regulatory commission and particular request, this can range from 0% to 100%. It’s common for regulators and consumer advocates to argue that revenues derived using assets and resources funded by customers should be returned to those customers. One counterargument is the public good of incentivizing utilities to take actions above and beyond their core responsibilities that can result in incremental customer benefits and support a sustainable business model for utilities.

Value-added services are also related to the evolving concept of the utility as a platform, with the distribution grid serving as the interface between the utility, customers, third parties, and the wholesale market. In this role, the utility serves a market enablement and value creation function, facilitating new third-party products and services, connecting buyers and sellers, and enabling market transactions, including selling grid services into the wholesale market. For example, in restructured states, utilities are also exploring ways to generate revenue from customer owned and sited DER that can be managed through behavioral programs or automated price signals. Depending on the grid need, customer assets can be aggregated to provide a temporal or locational grid need, while also providing a flexible resource for the wholesale market.

Ride-sharing services like Lyft and Uber, Airbnb, and Amazon Marketplace are often cited as examples of the platform model in other industries. A utility can earn revenue under this model by charging access fees or transaction-based fees; as more parties use the platform for transactions, revenues increase. Utilities may also form unregulated subsidiaries to participate in the market and transact on the platform. Online marketplaces may represent a first step towards the creation of a platform model, but further evolution will require significant grid modernization investments and regulatory and rate reform to align a utility’s revenue and business model with the new role and ensure a level playing field.

New Lines of Business

Some utilities are exploring and opening new lines of business, such as solar and DER installations, appliance servicing and repair, home warranty services, vegetation management, real estate services, and outdoor/security lighting. These services are typically offered through an unregulated affiliate subject to code of conduct rules to ensure a level playing field.

For example, Duke Energy provides home protection plans as market-based, unregulated offerings, which include but are not limited to home wiring repair, surge protection plans, and HVAC repair. Exelon (Constellation Energy), Edison International/Southern California Edison (Edison Energy and SoCore Energy, among others), and Southern Company (Southern Power) are a few of the companies offering competitive products and services through unregulated affiliates.

Several utilities are currently investing in technology companies and/or forming strategic partnerships with third parties. Aside from investment returns, partner utilities can earn enhanced visibility and understanding of the emerging technology landscape. They’re also in a position to identify potential partnership or pilot opportunities. For example, American Electric Power (AEP) invested $5 million in the energy storage software provider Greensmith and is partnering with them on an energy storage system in West Virginia. Ameren, National Grid, Southern Company, and Xcel Energy, have teamed with Energy Impact Partners—a private equity and venture capital firm—to invest in innovative energy technology companies.

As mentioned, code-of-conduct issues are typically front and center when proposing competitive services. These rules are intended to prevent utilities from using their position as a monopoly energy provider to create an unfair competitive advantage and often involve, at a minimum, creating a Chinese wall  to prevent information sharing between regulated and unregulated entities. Additionally, it’s often necessary to demonstrate that resources paid for by customers of the regulated entity are not used to support the unregulated business.

Conclusion 

The utility industry is continuing its move away from a commodity-based business where revenue is generated based on kWh sold on volumetric basis, and more toward a customer-centric model that seeks to uncover new sources of value for customers through products and services. Because regulated utilities will still be responsible for providing reliable service, a balance will need to be struck between how much the utility is allowed to earn to maintain and modernize the grid (grow the rate base), how much revenue may be allowed through the creation of new products and services (e.g., electrification, grid services), and how the cost of providing those services gets allocated across various customer classes through tariff structures. How each utility operationalizes this approach, will depend on several factors, including the regulatory treatment of the utility (are they vertically integrated or restructured), the pace of technology adoption, and the extent to which third-party service providers threaten the utility model.

Many utilities are under regulatory pressure to evolve their business models, others are growing their rate base through grid modernization, while others are proactively evaluating new revenue streams by creating new ways to engage their customers. The future path may require a reassertion and strengthening of the utility’s role as a trusted energy provider and enabler of choice. By aligning customer value with utility value through the offering of new utility products and services, utilities can establish a sustainable framework that helps them adapt to industry trends and capture new strategic growth opportunities. Whether responding to external regulatory pressures, or disruptive threats from third-party providers, utilities are wise to chart a course that provides affordable, reliable power, a modern grid that enables choice, and new approaches to deliver value to their customers.

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