Don’t be scared: Market demands utility diversification

Thomas A. Kerestes, EMA Inc.

The definition of “diversify” in relationship to commerce is to expand into new areas of business. Market pressures toward diversification within the electric utility industry these days have dramatically decreased. Instead, the media reports of retreats from ventures.

Alliant Energy Corp., for example, sold its ownership in a joint electricity-trading venture to Cargill Inc. to keep company investments focused in three areas: Alliant’s domestic utility, wholesale power plants and international investments. Overall, diversification is being thwarted by the energy trading scandal. It began with Enron irregularities, and, recently, Duke Energy Corp. admitted to 23 artificial energy trades used to raise volume on the electronic trading platform.

So, we see both a retreat and a holding pattern, with the tendency being to “stick to our knitting” in the current fluctuating market. With stock prices overall depressed, companies’ options are limited as far as expansion goes, but the market still demands action.

Why diversify?

The regulated market is not a place to secure high returns, so the lure of higher return on investment (than those offered by the regulated business) provides a compelling argument to expand into unregulated businesses. Additionally, there are only two sides to the ledger, income and expenses.

An organization can cut expenses by downsizing, resizing or right-sizing only so far. The other side of the ledger, income, must continually increase or organizations stagnate and wither. This is where diversification comes into play.

Professor Aneel G. Karnani of the University of Michigan Business School stated that there are five “possible growth directions” or methods of creating shareholder value.

  • Market penetration: expanding from the current business by gaining increased market share;
  • Globalization: expanding in the same business, but in a different geographic location;
  • Vertical integration: expanding either backwards or forwards;
  • Synergy: expanding into another related business; and,
  • Conglomerate: expanding into different unrelated businesses.

This begs the question, “Are you examining all your options, and how is that examination taking place?”

Market parameters are constantly changing, many of them lately in the downward direction. What role will your organization be playing in this brave new world? The financial strategists can play a significant role in setting direction, but are trigger points being created that will drive to tangible, actionable initiatives? The chosen strategy needs to be based on your company’s own resources and competitive position.

Step by step

Consider briefly each of the five growth directions. First, consider market penetration, which requires increasing market share or acquiring a larger piece of the pie (i.e., energy sales increase). This can be accomplished by acquiring additional customer territory, by increasing customer saturation through economic development efforts, or by enabling customers in the existing territory to consume more energy by customer class. (Again, economic expansion being the key driver.) For the latter, there should be metrics in place that track results of your economic development efforts. Ask penetrating question to determine whether they are really producing results.

Also, what metrics are tracked in relation to globalization? How large do you need to be before expanding beyond your local territory becomes a viable option? Organizations’ valuations are changing dramatically today and will move (either up or down) in the near future. What are the drivers for such migration and do you feel that you have some knowledge of the direction?

Third, vertical integration has its own value as a contribution to growth. While moving the transmission, generation and regulated distribution into different segments, it does not mean a divestiture at the holding company level. Greater control over the resource supply chain to the customer premise has its merits. What metrics are established that will value further vertical integration? Where are the opportunities that have surfaced due to the action, or lack of action, in the energy marketing realm?

Additionally, synergy between the electric industry and the gas industry has historically occurred. Many savings result when one utility supplies both electric and gas energy to a geographic area. Savings can be derived from areas other than acquisitions; consider creating agreements with cable, fiber and telephone companies to jointly install or own new facilities. Some have experimented with power quality services, security services or specialty lighting and engineering functions.

Finally, conglomerates are always an option. This path to growth assumes that the investor desires company management to make diversification decisions rather than themselves. This is a risk-laden path to growth and seldom achieves the desired outcome.

Utilities are finding themselves between a rock and hard place. It’s a good time to do what you do best, keep the lights on and make solid plans for the future, but don’t neglect developing action plans that include monitoring established metrics. These metrics must be created to trigger action when target set points are met. Only then can your organization move at a speed that ensures future success.

Thomas Kerestes, P.E., is principal consultant with EMA Inc. He can be reached at 651-639-5600 or at tkerestes@ema-inc.com. More information on EMA can be found at www.ema-inc.com.

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