by Tom Kerber, Parks Associates
The Internet of Things (IoT) and the deployment of smart products and services are disruptive forces that are transforming many businesses. The smart home creates new opportunities for manufacturers, service providers and utilities to develop solutions and capitalize on unmet consumer needs.
Traditionally, partnerships involve a bilateral agreement between two companies that have similar long-term goals and complement the other’s core competencies. Each company benefits from a long-term relationship that was well-planned, allowing the partners to reach a goal that neither company could achieve alone. Traditional partnerships take many months or even years to cultivate. Frequently, agreements are exclusive and prevent partners from making agreements with other competitors in the market.
The processes and thinking around partnerships must change radically to scale with the IoT. All of the individual products and services owned by each household must work together. Products must connect with numerous data sources to create a compelling user experience. Consumers will expect access to features and services on demand; therefore, partnerships must adapt to the new reality of the connected world.
Traditional long-term relationships remain valid, but companies also must understand that partnerships will evolve to be more transactional. The mindset of manufacturers, service providers and utilities must change and adapt to the scale of the Internet and open themselves to the potential of many loosely coupled partnerships.
Utility partnerships represent a significant revenue opportunity for thermostats, appliances, lighting and other devices that consume much of the overall residential load. Likely smart home product and service buyers are open to new business models, as well. For example, nearly 50 percent of likely buyers would allow service providers to adjust their thermostats.
Value Propositions for Traditional Energy Management
The value proposition for traditional energy management is based primarily on the return on investment in the form of energy savings. Selling products and services has been challenging; consumers are not naturally in the market for energy-saving devices. Given that consumer interest in stand-alone energy management products and services is low, the utility channel struggles to develop messaging and a strong selling process to bring these products and services into the mainstream.
In addition, utilities have a well-developed process for evaluating and implementing energy efficiency and demand response programs that takes years to complete. In that time, a manufacturer might have introduced two to three product enhancements or even new products. The regulatory framework constrains choice and inhibits innovation.
Contrast this to an open market approach where innovation and the market drive efficiency, not a bureaucratic process. Given the pace of change in the broader smart home market, utilities must consider alternatives to the traditional utility pilot approach: options that reward innovation, attract new partners and expand the breadth of energy management solutions.
Peak-time rebates are one example of a market-based approach to demand response. Peak-time rebates represent a pay-for-performance model that does not require exhaustive pilots and encourages third parties to enroll existing customers in the system. Creating a fixed incentive allows third parties to offer alternative, more compelling incentives to consumers in exchange for making minor changes to existing smart home devices during peak periods. In cases where the market incentive is insufficient to influence consumer decisions, moving the incentive upstream to an aggregator should be considered. Today, energy efficiency programs focus on overcoming barriers to adoption of high-efficiency products. Programs evaluate the impact of incentives applied along the value chain and select the incentive that can address the problem best. Demand response programs should consider upstream incentives in the same way that energy efficiency programs pay the retailers to stock specific SKUs or OEMs to develop a specific product.
Innovative Business Models
Demand response programs are transitioning from the traditional thermostat demand response business model where the utility markets, procures, installs and assumes the risk for long-term performance of the equipment to more innovative business models. The new, more cost-effective, pay-for-performance thermostat demand response business model leverages customer-owned thermostats. In doing so, it offers customer choice, uses both vendor and utility marketing, enables multiple installation channels and reduces the utility’s financial risk.
Austin Energy is one of the first utilities in the U.S. to move to a more cost-effective demand response business model that rewards consumers and thermostat vendors for participation. Under that program, Austin Energy pays thermostat vendors a recruiting fee and an annual fee of $30 to manage demand response events. The company opened up participation to six vendors: Alarm.com, ecobee, Filtrete, Nest, Nexia Home Intelligence and Vivint Inc. By partnering with multiple vendors, Austin Energy can ensure customers have a choice of what and where to buy or a choice to register a thermostat they already purchased. Austin Energy also pays its customers an $85 rebate on the purchase of a smart thermostat, regardless when it was purchased. Typical residential thermostat programs cost the utility $300 per home up front.
Another approach to gain access to third-party smart devices is to offer front-end incentives for adoption in return for access through the manufacturer connection. Paying an installation rebate instead of an ongoing annual fee might be a better option for the utility financially. Both approaches are viable and more cost-effective than traditional utility programs.
As the deployment of smart products accelerates, the combined potential for reducing energy consumption within a specific region becomes substantial. In some regions, manufacturers might be allowed to participate directly in energy markets, bidding demand response assets into the day-ahead market. Even in markets with excess generation capacity, a thermostat can generate some $20 annually on average by shifting loads away from peak periods. In other regions of the country that are more capacity-constrained, the value is much greater. In addition, energy markets can experience low-probability but high-consequence events that provide a much more substantial opportunity. Bad weather conditions combined with a plant shutdown might cause electricity prices to skyrocket, creating a windfall for those who can shift consumption away from peak periods. Manufacturers also can develop strategies for periods of overcapacity. Understanding the winners and losers when the price falls below costs will allow manufacturers to create programs to drive value for partners.
As a load-serving entity, electric utilities have competitive advantages over those that bid demand response only. Retail energy providers and municipal utilities are trading in energy markets, using load forecasting at an individual home level and models of demand response participation to reduce exposure to price fluctuations and to generate revenue.
Load forecasting has a long history. Typical load forecasting approaches use one of three mathematical models: regression, similar or design day, and neural networks. Smart meters enable a fourth model using the individual meter data to create a bottom-up forecast. Understanding the shape of the load is critical to energy retailers. Retailers can buy a hedge against block power purchases, but it is not financially viable to hedge against shape. Therefore, understanding the precise load shape is critical to the financial success of retailers that sell power at a fixed rate.
Several retail energy providers offer a free smart thermostat when a customer signs up for electricity services. Energy retailers then use the installed base of thermostats as demand response assets-not for grid stability but for financial advantage. The energy provider’s trading desk can evaluate the market and create a strategic buy-sell plan for the day-ahead market and evaluate real-time pricing for participation in the spot market. Understanding customers’ daily usage and likely participation in an event allows retailers to create a plan for purchasing power on the day-ahead market and bidding demand response into the spot market. Bidding both load and demand response concurrently opens up more options for financial gain than bidding load or demand response alone. Energy providers can bid high or short in the day-ahead market and use demand response to reduce cost and generate revenue. Given that the spot price of electricity can vary substantially, the risk and opportunity are huge.
The IoT is reshaping products and services for the home. Smart home products create a huge opportunity for partnerships among utilities, manufacturers and service providers.
Tom Kerber is director of research, home controls and energy at Parks Associates. He has a bachelor’s degree in systems engineering from the U.S. Naval Academy and a master’s in software engineering from The University of Texas. Follow him on Twitter @TomAKerber.