Your money or your life: Things you didn’t know to ask about AMR contracts

By Stephen C. Hadden & Ralph E. Abbott, Plexus Research Inc.

June 3, 2002 — Automatic Meter Reading (AMR) systems are used by almost all electric utilities. Some of these systems are quite small, gathering revenue meter data from large customers sites or load survey data from selected locations. But many AMR systems purchased in the past 15 years are very large, involving hundreds of thousands of meters, and costing $40 million and more. These systems are procured not only for routine operations, such as gathering revenue meter data, but also for strategic reasons, to support advanced services and the information needs of a restructuring marketplace.

Initial planning, definition, justification, specification, contracting, acceptance testing and ongoing operation of a large AMR system constitute a significant undertaking. Mistakes can be very costly, since the utility’s revenue and a very number of end devices may be affected. Yet the incentive to proceed is strong because the operating, tactical and strategic advantages of a timely AMR deployment are clear. Many of the best-managed utilities in the U.S. are concluding that they cannot afford not to acquire a pervasive AMR capability. But one size does not fit all. And no cookie-cutter approach to contracting begins to meet the needs of all utilities and suppliers.

The negotiating balance
AMR systems are not procured often, so there is little utility experience or “corporate memory” to avoid the pitfalls and minefields. A utility purchasing a large AMR system for the first time obviously has no prior firsthand experience. Some utilities have limited experience from prior smaller deployments. But large AMR systems are expected to serve for 12 to 20 years before being replaced. So any prior experience is usually quite limited or dated.

Unlike the utility, the successful AMR vendor proposes and writes contracts for system deployments frequently. Guess who knows all the tricks! Seemingly innocuous contract provisions can later rear up to bite the unsuspecting utility that may not have understood the issues underlying those provisions.

AMR vendors realize that utilities may not be on solid ground in preparing these complex procurement contracts, so AMR vendors usually offer to assist the utility by furnishing suggested or draft specifications, draft contracts and related documents. Are these suggested contract provisions usually well articulated and useful? Absolutely, and they save a lot of time. Are they biased in favor of the vendor? Sure they are! What is at stake? The purchase contract and the procurement specifications are the foundation of utility commitments that often exceed $100 million when all costs are considered, and directly affect the utility’s ability to bill its customers.

The contract must fairly and reasonably balance the interests of the utility and the supplier. AMR suppliers operate in a viciously competitive marketplace with more than 50 players vying for the business. Suppliers must be allowed to make a reasonable profit, or they will not be there when the utility needs their support, service or additional product. The supplier must not be held hostage and forced to accept extreme “you bet your company” terms and conditions. A wise utility will be careful to ensure that its AMR supplier is making a commercially viable business agreement that will produce a reasonable profit.

Types of AMR procurement contracts
Two prominent modalities describe most large AMR contracts: the utility purchases or leases the AMR system, or the utility outsources some or all of the ownership and operation of the AMR system.

The purchase contract requires greater detail and attention in the engineering specifications and test plans. These documents usually are appendices to the contract. In contrast, an outsourcing contract requires more meticulous attention to the contract provisions than does the outright purchase or lease. But in both cases the contract defines the terms of the binding “marriage” that both parties will live with for many years.

* Purchase or lease–The utility purchases and takes title to the entire system, and then installs and operates that system. The vendor is a classical utility supplier of hardware, software, documentation, installation oversight, training and start-up support to get the system running. This is buying AMR the “old way”, where the system was often rate-based by regulated utilities. It is still a very common way to procure AMR.
* Full or partial outsourcing–The former Cellnet Data Systems (SchlumbergerSema acquired Cellnet Data Systems our of Chapter 11 bankruptcy in May 2000) is credited with pioneering the outsource business model in which the supplier sells only part of the AMR system to the utility and capitalizes the rest of the system itself. The supplier then remains responsible for acquiring and processing the data. Meter readings are furnished to the utility by the supplier at a contractually established price on a “cents per meter reading” basis. The supplier may establish a regional data collection and processing center, not necessarily within the service territory of the utility. This approach allows the utility to avoid some of the substantial capital cost of an AMR system, paying only for the data. Different prices typically apply for different kinds of data. Time-of-use data or interval data, for example, may cost the utility more than simple once-a-month total energy readings.

Contract issues
Poor procurement specifications, accompanied by weak or incomplete contracts, invite performance problems and unforeseen costs. These exposures can be very substantial. They fall into logical categories: system performance, supplier performance, utility performance, and contingencies, recourse and context.

This article discusses one issue in each of these categories to illustrate their importance and dimensions. Dozens of other similar issues can have similarly helpful or destructive impacts and must be addressed in the contract. Readers will recognize that this discussion is not a substitute for competent legal advice on such matters. Rather, it is a primer to help both utilities and suppliers examine the issues and alternatives.

System performance
It seems obvious to agree to have factory and field acceptance tests. Yet it is surprising how many utilities will agree to tests that are ineffective or have no defined consequences. Often the AMR supplier has not previously combined all the features of the new system the utility is buying (or outsourcing). Further, the utility’s expectations may not perfectly match its stated intents. Substantive system tests help both parties be sure they understand each other and avoid costly problems later. They help the utility assure that the AMR supplier meets its commitments. And they help the supplier be sure the utility understands what it will get and cannot later withhold payment based on a previously unmentioned expectation. Preplanned tests assure that the parties agree on the details before large costs are incurred for deployment, rather than disagree afterward.

These tests demonstrate end-to-end operation and data retrieval with a small but representative sample of the hardware and software elements that will be installed for the utility. The factory test illuminates hardware and communication problems, protocol conflicts and (especially) master station software functions. The test should be structured to stress the system performance limits insofar as that is possible. Obviously, a Factory Acceptance Test does not encompass the full range of real-world challenges and environmental stress, but a well-written factory test enables a disciplined system development process and will minimize problems (and costs) in the field. Similarly, the Field Acceptance Test assures that the system will operate successfully in the utility operating environment before large numbers of units are deployed. Problems can be solved during these tests at costs that are dramatically lower than later, when the system is partly or fully deployed and troubles may interfere with utility operations.

The contract normally defines strict pass/fail criteria for the acceptance tests. If the AMR system fails a test, the contract stipulates specific actions that allow remediation by the supplier, followed by re-test(s). A failed test may precipitate adverse financial consequences to the supplier, such as a penalty or a payment delay. A system test is also a useful progress milestone that may toggle progress payments to the supplier.

These tests constitute cost and administrative burdens, and utilities must expect to incur them. This is very cheap insurance. One utility nearly agreed to contract clauses that required it to pay in full for AMR equipment upon delivery to the utility loading dock, before installation and without any test at all. Under just such purchase terms, a financially pressed AMR supplier once delivered thousands of boxes containing empty AMR device housings, just to get paid so that it could finance production of the real AMR equipment. Both the supplier and the utility would have fared better if the contract had required more substantive performance and provided workable contingencies for supplier distress.

Supplier performance
In an outsourcing AMR contract the supplier should be held to a high standard of timely and accurate delivery of readings. If the system fails to provide the desired meter readings, the outsourcing supplier normally agrees to obtain those readings by some other means, even by manual meter reading. The performance expectation for this alternate meter reading must also be specified. The supplier’s obligation to provide meter readings when the system is down must be realistic, but it also must be enforceable and must meet the utility’s essential business requirements.

Numerous approaches can achieve this, but some are more workable than others. An agreement may require supplier-provided meter readings to reflect the energy consumption of the customers, in aggregate, to within, say, two percent each month. But this allows nearly unlimited individual meter reading errors, as long as the total reported energy consumption is correct. Utility readers may think such an approach is unlikely, but it has happened. We’ve seen it in draft contracts before correcting it to require individual meter readings to be accurate.

Utility performance
AMR systems typically rely on things like outside infrastructure and installation, spectrum licenses, communication backhaul, installation contractors and pole attachments. These are essential to basic system operation yet the supplier generally has comparatively little control over them. An essential principle of a viable contract is that neither party may be held responsible for items, or the consequences of items, over which it has no direct control.

An AMR deployment is a bilateral endeavor. Both parties have major, inter-dependent interests and responsibilities. If the utility fails to meet its obligations, this must absolve the supplier of its responsibility to fulfill obligations that depend on utility action. Clearly, it’s important to agree what the utility will do, in writing, in the contract, and what will be the consequences if the utility defaults or is late.

Contingencies, recourse, context
More than 50 suppliers offer a wide variety of AMR systems. Several fail and go out of business each year. New companies, full of enthusiasm–and sometimes naivety–enter the market each year. Others suppliers are merged or acquired. How does the utility assure succession of its interests in this volatile business arena?

The suppliers include large well-established companies and at least three new start-ups with fresh ideas every year. The largest AMR suppliers evolved from small companies formed in the last 20 years. The major meter manufacturers have been singularly unsuccessful at internally developing what have become the most popular AMR systems. Smaller companies have actually driven the AMR business more creatively and more successfully than any large company. No utility should assume that selecting a large “brand name” supplier insulates the utility from an AMR system that may become “stranded.”

An AMR supplier may become unwilling or unable to complete its obligations under the contract. If the company goes out of business entirely, and no successor can provide compatible equipment to complete or support the AMR system, the utility may need access to the entire intellectual property, personnel, tooling, documentation and drawings to have additional equipment manufactured by others and/or to arrange the technical support that had previously been provided by the supplier.

A properly structured contract will give the utility access to necessary information and the right to have additional units manufactured. This is usually done in the form of a technology escrow arrangement. Occurrence of a prescribed set of circumstances–such as a Chapter 7 bankruptcy–will grant the utility free access to the escrow package. The supplier must agree to an escrow arrangement that ensures that the utility, or a third party of its designation, will have complete and accurate data, drawings, assembly instructions, part lists, test plans and procedures, releases, software, and unconstrained access to all contractors, former employees and developers.

Consider what will happen in the above situation–supplier exits the business without a successor–if the component and system designs and tests were not well documented when the system was first commissioned. The utility will be stranded with no way to read its meters. In effect, the financial crisis at the AMR supplier creates a financial crisis for the utility. More than one utility has come perilously close to facing this situation. All these contract issues are interdependent and, together, support the viability of the parties and the contract for the long term.

Of course, there are many more than 10 things to consider. Other issues that should be addressed in an AMR procurement contract include the following, which must respect and balance the legitimate business needs of both parties within the practical limits of what technology management can achieve amid real-world uncertainties.

System and subsystem specifications (technical and functional)
Hardware and software documentation
Item and system performance
Delivery requirements
Incoming inspection
Pricing and price escalation/decline
Pricing relative to other AMR customers
User manuals
Integration with utility legacy systems
Spares and maintenance
System enhancements
Expanded services (more time-of-use reads, etc.) and related pricing
Liquidated damages for failure to perform (by either party)
Intellectual property rights
Contract termination
Contract assignment and succession

Individual circumstances will dictate additional issues. For many issues, it is also necessary or helpful to agree on what to do if things do not go as planned. An old non-lawyer once advised his children, “Education is what you get when you read the fine print. Experience is what you get when you don’t.” When making long term agreements with major strategic consequences, it’s good for both the utility and the AMR supplier to think carefully and agree in advance what that fine print says.

About the Author: Hadden is vice president, and Abbott is president of Plexus Research Inc. Both may be reached by phone at 978-263-6080. Hadden’s e-mail is [email protected]; Abbott’s e-mail is [email protected]

This article is scheduled to appear in Electric Light & Power Magazine, June 2002. To read more, visit http://elp.pennnet.com/Articles/Print_TOC.cfm?Section=Articles&SubSection=CurrentIssue.