Anna Sabasteanski, Principal,
The Asset Management Network Inc.
Utilities are used to working with the physical plant. Generating plants, transmission and distribution systems are tangible, and have a value that can be easily measured. When the environments were highly regulated, it was easy to rely on these physical assets for valuation. But now that utilities have been deregulated, it is more critical than ever that intangible assets are captured and their value recognized.
Intangible assets drive today’s economy. Traditionally, the difference between the book value of a company and the market value was considered goodwill, and attributed to factors such as brand and customers. Today, intangible assets reflect the impact of information technology and the significant changes this has brought to the way we conduct business.
In fact, a major reason that the valuation models for emerging companies has diverged so greatly from the traditional models is because the markets are taking into account intangible assets that traditional valuation models do not easily recognize. Economists are having a field day trying to analyze this phenomenon, and it is anticipated that within the next few years, accounting models will be established that determine how intangibles can be recognized inside general accounting principles.
The U.S. Department of Commerce is investigating how to capture and measure this value. They are looking at such phenomena as:
- The quality of a product may improve without increasing the price.
- Information may be the only asset a company owns.
- Data captured from customer behavior has value.
- New transaction methods have changed the metrics of productivity and investment.
- Physical assets in some industries may become liabilities due to changes in business processes or technology.
What does all this mean for utilities? There are four general areas to consider: Overall corporate valuation, human capital, structural capital and customer capital. (See figure.)
Overall corporate valuation
Overall corporate valuation includes metrics around the market-to-book ratios, market value to replacement costs, and out-performance (relative to competitors). These measurements are relatively straightforward and are used as traditional calculations of goodwill. For example, the NCI method of calculating the value of a brand starts with the market value and compares the return on the investment to competitors with similar tangible assets to calculate the relative return on assets. These calculations can be easily done by your accountant and are extremely useful in benchmarking your performance.
In public utilities, measurements of intangible assets were largely negative until the effects of deregulation in the mid-1980s. Since then, the value of tangible assets has steadily declined while intangibles have steadily increased. Measuring your company against its industry sector will help you understand where to place investment dollars and how you will ultimately fare in the highly competitive marketplace.
In the deregulated industry, competition and globalization have led to a high degree of merger and acquisition activity. Understanding corporate valuations and incorporating both tangible and intangible metrics is essential to participate effectively in this environment. In fact, intangible metrics can be applied to acquisition targets to help determine true valuation. Relative return on assets can help to indicate whether a company is under-performing or that its true market value has just not been realized.
Human capital includes measurements around innovation, employee tenure, turnover, experience, learning, attitudes, and knowledge. These metrics can be tracked looking at revenue from new products, gross margin from new products, employee replacements costs, the value of research and development, and so on. Understanding these metrics will have a direct impact on the ability to attract and retain employees and will also provide measurements of how much the market values new products and services that you produce.
Prior to deregulation, research and development was primarily undertaken by organizations such as EPRI, underwritten by industry contributors. Now, each individual company will have to assume the costs of research and development. Instead of sharing, the intellectual property that is developed becomes proprietary, valuable, and essential to track.
As a result of proprietary development and the increased reliance on software, the employee base is also more valuable now. The training and skills required will become more and more specialized, resulting in increased need to manage human capital very effectively.
Structural capital includes knowledge assets such as branding, advertising, quality control, patents, processes, security, trademarks and copyrights, as well as working capital turnover and back-office support. These assets are valued based on how well they increase knowledge and organizational efficiency. Calculations are made around comparative costs, operating efficiency, and business process audits.
While regulated, utilities had little need to develop brand awareness or related marketing and advertising campaigns. In the light of competition, these efforts are required in order to compete. Utilities now create brands not only against traditional trademarks, but are also developing new ways to differentiate the commodity by branding to specific consumer sectors, such as those who are environmentally conscious.
Internal operations were covered at cost under regulation and there was no incentive to invest in reducing those costs, since the return was not allowed. This led to disincentives to invest. This situation has been turned on its head. Utilities now must invest in efficiency and cost reduction in order to stay competitive, and the value in doing this can now be recognized.
A whole new set of challenges to traditional transaction models is raised with the advent of e-marketplaces. Understanding how to re-engineer core business processes to participate in these marketplaces is critical. Similarly, understanding how to value a transaction in an environment that has moved rapidly from paper to electronic processing, and is rapidly adding even more automated functions with the use of agents and automated payment systems, is essential. It has an impact on how you measure the size of the operation, the cost of sales and support requirements. With further optimization within these exchanges, transactions among suppliers can be fully automated and reduce the cost of a transaction close to zero while dramatically increasing the efficiency of service delivery. The difference between the manual cost and the automated cost represents an intangible value that can be captured and measured.
Customer capital measurements surround satisfaction, alliance, loyalty and so on. Metrics may include financial performance, retention rates, cultivation rates, price tolerance, and life expectancy. The key measurement in this case is to aggregate this data around the customer lifetime value. To really understand this, technology, such as a data warehouse, to analyze the tenure and profitability of customers over time is critical.
When utilities were regulated, customers took them for granted and the value of the relationship was somewhat irrelevant. In a competitive environment, the customer relationship is king. Now that those customers can move from one supplier to another whenever they wish, customer relationship management is critical to the success of the company.
CRM systems and their internal data warehousing applications make it possible to convert customer records (data) into knowledge. Mining information from customer billing, usage, purchases and demographics provides decision support at all levels of the organization, but is also the foundation for valuation of the customer data as an intangible asset.
In addition to wrestling with these economic issues, utilities must continue to manage their traditional assets and adapt to the new Department of Energy guidelines. These guidelines set out specific requirements that asset management systems must meet. These are centralized asset tracking, centralized change control, lockout, and market value.
As utilities gear up to accommodate these new requirements, it is crucial that they extend past the physical plant to take into account the capture and management of their new intangible assets. Over time, the intangible assets will provide greater value, and will be the most potent indication of a company’s long-term success.
The outer ring represents the general categories, the next layer provides examples, and the inner circle shows supporting technology.