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The Global Energy Retailing Revolution

Management Consulting Services

The Global Energy Retailing Revolution 1

Contents

Page

1. Introduction 2

2. Forces of Change 4

2.1 Deregulation 4

2.2 Convergence 6

2.3 The Internet and e-business 9

2.4 Globalisation 12

2.5 Shareholder pressure 13

2.6 In conclusion 14

3. Future Energy Retailing Trends 15

3.1 A new taxonomy 15

3.2 Specialisation and focus 16

3.3 Segmentation 18

3.4 The rise of e-tailing 22

3.5 In conclusion 23

4. Today’s Plays 25

4.1 Choose a final destination 25

4.2 Build a viable brand 25

4.3 Manage the changing cost chain 26

4.4 Capture scale and scope economies 28

4.5 Build new core competencies 28

4.6 Revolutionise and energise the organisation 29

4.7 Leverage new technology 29

5. The Way Forward 30

1. Introduction

This report provides a unique view of what future global energy retailing will be like. Readers will benefitby being exposed to:

■ The forces of change influencing the energy retailing arena and their likely impact,

■ Consumer and market behaviour in deregulating countries around the globe,

■ A framework for thinking about how the industry will evolve and their own future direction, and

■ What they should do today to succeed tomorrow.

To produce this report, PricewaterhouseCoopers has conducted research across the globe, including theUnited Kingdom, Norway, Sweden, Finland, Denmark, Germany, Spain, Italy, Australia, New Zealand andthe United States. The information gathered provides the evidence for the conclusions and insightsdocumented in this report.

Evidence of the major forces of change impacting energy retailing is presented. The report then discusseshow these forces are likely to shape the future energy retailing paradigm. Major future trends of energyretailing are also described. Lastly, the seven moves companies should make today to ensure their successtomorrow are outlined.

The evidence suggests that energy markets around the globe are being transformed in a revolutionarymanner by new and irresistable external forces. Competition, convergence, technology, globalisation andcapital markets are combining to force change at an unprecedented speed:

■ Competition is empowering a new breed of technology-enabled consumers, and the balance of poweris shifting their way. They will switch retailers on an increasing scale in an environment of lower pricesand narrowing retail margins.

■ Convergence, hastened by new technology, will cause a race to identify, create and fill new coherentmarket spaces. Participants in this race will include new entrants to energy retailing, potentially “bigbrand” retailers with proven customer relationship management skills. At the heart of convergence isthe recognition that customer relationships are one of the most valuable assets of an enterprise.

■ E-Business will create new ways to build these customer relationships, as well as reduce costs andeliminate traditional processes.

■ Globalisation will see the erosion of the traditional geographic boundaries of incumbents as theybecome players on a global stage.

■ Capital markets will exert a strong influence on newly privatised companies.

These forces, coupled with continued regulatory pressure, will cause further fragmentation of the energyvalue chain. Greater fragmentation will, in turn, give rise to a new industry taxonomy and a broad choiceof future business models. Incumbents face tough decisions about the future direction that offers them thebest chance of success. Specialisation and focus will be the hallmarks of tomorrow’s successful enterprises.

The benefits derived from specialisation and focus will drive the separation of retailing activities, serviceprovision and distribution. The industry will increasingly expand horizontally as players specialise indifferent parts of the new value chain. Specialist service providers will promote the growth of outsourcing,particularly for back-office activities. Those who stay in retailing will compete in a new world ofsegmented, consumer-driven markets.

2 The Global Energy Retailing Revolution


This report highlights that energy retailing in the future will be very different from the past. Making theright moves today is vital to tomorrow’s success. Attention should be directed towards dynamicsegmentation and executing marketing strategies customised to each segment. Strong cost pressures andthe prospect of low returns will be the order of the day as incumbents face a double margin squeeze.Competition will decrease energy prices but also demand a greater investment in customer relationshipmanagement, branding and new channel development. Capitalising on the benefits of new technology –capturing economies of scale and scope, stripping out costs, removing customer barriers – will be essentialto building competitive advantage.

In essence, tomorrow’s successful energy retailers will be market and customer focused specialists withexceptional competencies in technology-enabled customer relationship management, marketing, sellingand customer care.

John FishPartner, Management Consulting ServicesGlobal Energy and Mining GroupMelbourne, Australia

2. Forces of Change

Five forces – deregulation, convergence, e-business, globalisation andshareholder pressure – are revolutionising the energy industry and redefiningthe successful retailer of tomorrow.

2.1 DeregulationDeregulation is stimulating a new breed of energy consumer, and the balance of power is shifting theirway. Technology, particularly the Internet, is providing new ways to fulfil consumer needs. Customerswitching and churn will occur on an increasing scale in an environment of narrowing energy pricedifferentials and margins.

2.1.1 The unleashed consumerHistorically, energy consumers have had little, if any, say in how they purchased electricity and naturalgas, from whom they purchased and the price they paid. However, consumers are already experiencinggreater convenience, value and choice in other deregulated industries such as telecom. They will expectthe same when they have the right to choose their energy retailer.

Deregulation, competition, convergence and the Internet are all shifting the balance of power in favour ofthese newly empowered energy consumers.

Energy, like many products and services, is entering the era of “open sky retailing” where anybody can sell anything as long as they can earn the trust of the consumer. Customer relationship factors are replacingtradition and technical factors in consumers’ purchasing decisions. Today’s unleashed consumers are smartand give more thought to how, and from whom, they purchase their energy. The skies are open for theretailer who can cement relationships with, and secure loyalty from, these unleashed consumers.

2.1.2 Prices and marginsAs deregulated energy markets develop and mature, competitor pricing converges and margins narrow.Differentials such as ownership structure, source fuel, supply and demand balance, and appetite for riskcombine with regulatory pressures to encourage price competition.

In Germany, where price has been the dominant driver for choosing a retailer, prices have decreased by around 30%.

In the UK, the wholesale price of electricity has dropped between 15% and 20%.

After hourly metering was abandoned in Sweden in November 1999, many competitors cut their prices by as much as 25%. In Finland, where hourly metering was dropped in November 1998, nearly 80 companiesreduced their retail prices by an average of 10% to 14% from the start of 1998 until the beginning of 1999.Swedish Vattenfall slashed their prices by 25% when they entered the Finnish market.

In Australia, several years ago some market participants were forecasting long-range wholesale electricityprices of $38 to $40/MWh. Rarely have they reached this level and, in fact, have averaged in the low$20’s/MWh range (AFR 16/2/2000 and 22/2/2000). It is not uncommon to find electricity prices down by30% to 40% amongst large Australian business customers (AFR 21/12/99).



Gas deregulation in Georgia, USA has resulted in residential customers typically saving between 6% and 9% (CERA 3/99).

In fiercely contested areas, retail gross margins have struggled to remain positive. In Germany, marginsearned in the commercial and industrial market segment are low or nearly non-existent. In Australia, evenat the smaller end of the industrial and commercial segment, gross margins have seldom exceeded 5%.

Global experience suggests retail margins in the domestic sector will also narrow, although this is difficultto quantify. In Germany, margins in the residential segment have decreased significantly as a result ofcompetition between companies such as Yello-Strom, ares-energie and RWE (avanza).

Open competition will drive greater investment in innovation, new product development, new servicecreation, energy trading initiatives and process improvements which may, in turn, further squeeze margins.

Moreover, the Internet will make price comparison easier. In Germany, some Internet sites already providethe ability to compare the tariffs of various retailers. As the Internet offers consumers equal and rapid accessto all retailers, price differentials will become increasingly difficult to maintain. Retailers will then need tocompete on relationships and service.

2.1.3 Switching and churnWhile consumer inertia is a powerful force, switching and churn will occur on an increasing scale due toa combination of:

■ New entrant offerings – more choice, more channels and Internet transparency, and

■ More knowledgeable, competition-aware consumers.

Switching between retailers, initially driven mainly by price, will be easier and will become an acceptedpractice as with other products.

In Australia, 30% of contestable electricity end-users have changed their retailer each year (AFR 21/12/99).Future switching levels among residential consumers will depend heavily on whether metering is required,or profiling solutions are used, for market settlement.

In each of the Nordic countries, local market barriers initially made switching difficult and expensive. One of the most common barriers was the requirement to pay a set fee to cover switching costs. Anotherwas the necessity to install an hourly meter, usually paid for by the consumer, making the cost effectivenessof switching retailers doubtful for domestic customers. The rate of switching, however, has increased quitesignificantly recently as barriers have been removed. For example:

■ From April 1997 to January 2000, 10.9% of Norway’s 2.2 million consumers changed their retailer. Of these, 112,350, or a little over 5% of Norwegian households, switched during 1999 alone.

■ It was estimated that around 10% of the 4 million Swedish households would switch during the firstyear after abandoning the metering requirement, i.e. starting November 1999. Three months later, inFebruary 2000, Sydkraft, a major Swedish electricity company, reported a loss of about 3.5% ofcustomers and a gain of 1%. A Gallup study found that 15% of Swedish consumers stated it was “veryprobable” that they would change their retailer during the coming year; when the “fairly probables” are included, the figure increases to 30%.

■ As of June 1999, around 0.8% of Finland’s 2.5 million consumers had switched retailer. A survey in thespring of 1998 found that about two-thirds of Finnish consumers were so pleased with their incumbentretailer that they were not planning to look for other alternatives.

In Germany, residential switching has been an immediate reality, unlike the Nordic countries, due to theuse of profiling and generalised tariffs. The level of switching among domestic consumers has been lowerthan initially expected. Although most consumers are aware of their ability to switch and nearly 50% havethought about it, less than 2% have switched. This has been due to several reasons: incumbents have metcompetitor prices, many of the new entrants still have to build their brands, factors other than price haveentered the switching equation, and there is low interest in the product. Switching levels, however, areanticipated to increase as marketing initiatives improve and more attractive bundles of products andservices come on the market.

UK experience suggests that switching rates may build to between 20% and 25% over time. In one year,ending March 2000, ScottishPower reportedly won 10,000 and lost 3,000 customers per week on average.These numbers represent a 10% gain and a 4% churn per annum. For the UK electricity and gas marketscombined, we estimate that 22% of customers have switched their retailer. Of these, 15%, or 3% of allcustomers, have returned to their original retailer. The main reasons for the switch-back include problemswith transfer processes and problems with the account, such as unpaid debt.

Among residential consumers, potential new entrants in the form of ”major brand” retailers will escalateswitching and churn rates as they have the scale advantages to offer value, service, convenience and atrusted brand. Furthermore, they may revert to predatory pricing as they look to earn their profit off thetotal, multiple product, lifetime value of the customer relationship, not just off energy products.

2.2 ConvergenceConvergence is playing a major role in transforming energy markets. It is being felt widely as companiesrace to identify, create and fill new and coherent “market spaces”. At the heart of convergence is theapplication of new technology to the recognition that customer relationships are one of the most valuable,and often the most unexplored, assets of an enterprise.

Convergence is not new, but advances in three key technologies are enabling an unprecedentedmomentum – e-commerce, digital technology and consumer database technology. Retailers, particularlymajor brand retailers who have the trust of a large customer base, are increasingly looking to the world of“open sky retailing” where they sell sought after bundles of products and services that transcend “legacy”markets. Old product and service boundaries are rapidly disappearing as companies seek to gaincompetitive advantage and capitalise on the synergies now available between energy, retailing, telecom,media, banking and other products and services (see Figure 1: New Market Spaces in a Converging World).

These shifting consumer markets are causing a race among retailers to secure economies of scope byidentifying then dominating new and bigger market spaces. To have meaning and value, market spacesmust be filled with compelling, relevant and complementary products and services. In the energy marketthe race is on to create and own a space in consumers’ minds around “home products and services”including offerings such as safety switches, smoke alarms, home security packages, home wiring safetychecks and even home moving services.

Convergence is also causing significant demand-side changes. Consumers are looking at markets differently.They are now less likely to view vendors through their products and services, but rather through therelationships they have with them. Energy retailers, for example, must look to build relationships, such as“energy” or “home services” relationships, with customers. Core products and services will become amuch smaller part of the overall value proposition. Hence, convergence means building new valuepropositions. This will change the nature of competition. Instead of competing for market share, retailerswill increasingly compete for share of relationships. Success will come to those businesses deliveringsuperior customer value propositions through new and different relationships. This will require aligning the whole architecture of the company to the delivery of value propositions.

Incumbency is no longer the advantage it was. Barriers to market entry are tumbling down. Energy retailerswill be competing against “major brand bricks and mortar” retailers as well as Internet-based “virtual



Figure 1: New Market Spaces in a Converging World

retailers”. Both may target energy companies for their inherent customer access. Furthermore, suchcompetitors can afford to offer energy products at minimal margins for this access, with the addedadvantage of probably reducing churn in their own customer base.

Incumbents with their narrow product offerings are vulnerable. Convergence strategies are needed becausethey will improve the bottom line in two ways – leveraging scope through broadening the product andservice range and leveraging scale through growing the customer base by acquisition and churn reduction.

Middle Market

Markets had clear cut boundaries in the past…

…but not any longer

Much of the critical competitive activity is now where markets intersect with each other

ElectricityLondon Electricity

Endesa, Enel,TXU, ConEd

InsuranceNorwich Union,

Prudential, Axia

InformationTechnologyMicrosoft,

Yahoo!

GasCentrica, Enron,

Statoil

TelecomsBT, MCI, AT&T,Telstra, Optus

BroadcastingBskyB, NBC,

Warner

PetrolShell, BP,Q8, Elf

RetailM&S,

Intermarche,Woolworths,Coles Myer,

Macy’s BankingRBS, NatWest,

BNP, UBS,CBA, Citibank

EntertainmentDisney

ElectricityIndustry

InsuranceIndustry

Sears/Allstate

ITIndustry

GasIndustry

TelecomIndustry

Telecoms

TelecomsMedia

BroadcastingIndustry

Petrol

RetailIndustry

BankingIndustry

EntertainmentIndustry

Disney StoresRainforest Cafe

BT+BSkyB=BIB(British InteractiveBroadcasting)

Time Warner & AOL

Yahoo!, MCI

Microsoft

Electricity companies looking at Internet access through wall sockets

Warner(Cartoon Network)

Retailers cardsWoolworths,Coles Myer,Branded creditcards (GM)

Barclays,Citi/Travellers

British Gas offer insuranceAXA

Tesco, IntermarcheColes, Woolworths

United EnergyEndesa, VIAG, Vivendi, Wind

Telstra, Optus

UE, TXU, OriginEnergy, Enron

A Converging World

Europe:

■ In Sweden, Vattenfall has created abonnera.com to sell telecom, electricity and insurance over the Internet.

■ In 1996, a new telecom company, Enitel, was formed by seven Norwegian electricity companieswith another 23 joining in 1997. Enitel has become a service provider of telecom, datacommunication, Internet and telecom systems to residential and business customers.

■ Statoil, a major Norwegian oil and gas company, put electricity offers to 900,000 consumersholding the syndicated-owned Domino loyalty card in 1998. It is reported that 40,000 customerssigned up during this direct mail campaign.

■ Power Trade has been established by three major energy brokers (CBF Energimegling AS, NorwegianEnergy Brokers AS and M3 Kraft AS) and an IT company, Software Scenario AS, to provide onlinepower trading for Nordic countries.

■ Hafslund, a Norwegian electricity company, and Fastweb, an Internet company, formed a NOK 10million joint venture to offer development of homepages on the Internet to householders andbusinesses.

■ Best Energy of Germany has been started by Mobilcom, a telecom company, and BEWAG, anincumbent, to market low price electricity and telecom services.

■ Large catalogue retailers, such as Quelle, are retailing electricity under their own brand usingincumbents, such as RWE, as service providers.

■ Ares-energie has joined forces with Promarkt and other retailers of white goods and electricalappliances to offer customers the opportunity to pay for such purchases on their electricity bills. A variety of electricity pricing options are also offered, including the choice of green power.

■ Metro, the largest consumer goods retailer in Germany, and Bayernwerk have joined forces to retailelectricity to business customers (with bills higher than Euro 30,000) initially and to domesticconsumers as a second step.

■ HEW and Shell have formed a joint venture called NewPower to sell green power (wind and solar).

■ In Spain, the oil company Repsol-YPF, majority owner of the gas company, Gas Natural, has tried to acquire Iberdrola, Spain’s second largest electricity company.

UK:

■ Centrica has acquired the Automobile Association.

■ The Virgin group has entered the energy market.

■ ScottishPower and the Royal Bank of Scotland have formed a 70 million pound joint venture tomarket a package of home services to residential and small business consumers over the Internet(Inside Energy 14/1/2000).

■ British Energy has moved into the Internet space through an equity holding in the property searchcompany, HomeDirectory.com (Inside Energy 14/1/2000).

■ BP Amoco has started an e-business gas trading service for its UK business customers (UK Gas Report 14/1/2000).

■ Centrica plans to move into telecom, extending its portfolio of electricity, gas, appliancemaintenance, plumbing, financial services and roadside assistance (UK Gas Report).



US:

■ AOL and Time Warner are in a $534 billion merger (AFR 11/1/2000).

■ Enron, already a player in the electric and gas industries, entered the water industry by buyingWessex (UK) and forming water subsidiary Azurix.

■ Circle K has its own brand phone card.

Australasia:

■ Powercor has a co-branded mortgage with BankWest which includes rebates on electricity bills(AFR 26/2/97).

■ United Energy formed an alliance with AAPT (Sydney Morning Herald 26/3/97) and is now building a telecom arm (AFR 3/2/2000).

■ Dual fuel offers will become the norm as a result of electricity companies buying Victorian natural gas companies in 1999.

■ News Corporation will invest another $200 million in One.Tel (AFR 24/11/99).

■ Woolworths offers “Ezy Banking” with Ezy Reward Points loyalty program.

■ Telstra plans to buy part of OzEmail for $300 million (AFR 11/2/2000).

■ Commonwealth Bank and ninemsn have formed an online partnership.

■ Westpac Bank and f2, the Internet arm of John Fairfax Holdings, have formed an alliance (AFR 17/2/2000).

■ Energex offers dual fuel, hot water systems and telecom through its shareholding in PowerTel.

■ Pulse Energy is planning to enable customers to pay their electricity and gas bills at Shell servicestations, receiving Fly Buy points in the process (AFR 9/3/2000).

■ AGL is poised to unveil an e-commerce strategy and launch a co-branded credit card.

2.3 The Internet and e-businessTechnology advances will unlock synergies by creating new ways to strengthen customer relationships,reduce costs and eliminate traditional processes.

The growth of the Internet and e-business is staggering. It has been estimated that as of June 1999, therewere nearly 180 million Internet users world-wide. Global e-business is expected to grow at a compoundrate of 95%, from $US50 million in 1998 to $US733 billion in 2002 (AFR 6/1/2000).

The power of the Internet and e-business is in their ability to accelerate market restructuring, redefinebusiness processes, drive down costs and force a new customer-centric focus in all parts of the valuechain. New sales and communication channels are emerging at an ever increasing pace to meet theconvenience needs of consumers. Traditional routes such as mail, telephone and account managementwill become parts of a broader channel-mix that will include direct “e-tailers”, brokers and affiliationssuch as employers, clubs, church groups and local authorities (see Figure 2: New Channels to Customers).

For example:

■ In the US, more than 56 million online purchases were made from the home in the six months endingMarch 1999. 33% of US homes have Internet access, and 47% of all online users purchased somethingin that six month period (IT Daily 25/3/99).

■ In the UK, 25% of Britons use the Internet, and it is estimated that online shopping will be wortharound £3.1 billion by 2003 (IBM Computer Today 2/99).

■ In the Scandinavian countries, around one-third of the population is connected to the Internet. InNorway, it is reported that 50% of consumers switching their retailer use the Internet as their majorsource of information.

■ In New Zealand, nearly 30% of the population is expected to have Internet access by December 2000.It is anticipated that just over 1 million people will shop online by 2004 (International Market InsightReports 7/2/200).

■ In Australia:

– Household Internet access surged by 27% in one year ending August 1999 which means that 1.6 million(almost one in four) households have the means to interact online. During the same period, almost5% of adults used the Internet for shopping compared to 3% a year ago. Of these, 27% made morethan five purchases online (AFR 21/12/99);

– Customers can already pay their bills online with Ergon Energy, United Energy and NorthPower; and

– Victoria is piloting a kiosk system called Maxi that allows the public to conduct simple transactionselectronically. Consumers can complete 26 transactions from 7 different agencies, including payingEastern Energy accounts.

The two-way communication of e-business, coupled with fast, economic transactions, has shifted thesource of retailing competitive advantage away from owning transaction processing assets and towardleveraging customer information and marketing assets.

A META group survey found that energy companies believe the most critical e-business investments are for customer service and support, sales and marketing. Furthermore, Customer Relationship Managementwill be a critical success factor for energy companies during the next 5 years (META Group 1/00). Retailersand their customers are already benefiting from the online marketing, billing, revenue collection andenquiry applications which, ultimately, will lead to a significant streamlining of processes and, perhapsmore importantly, will cause the customer to feel empowered. Call centres will be re-engineered and webenabled. For example, German retailers Yello-Strom and ares-energie rely solely on their Internet and callcentre capabilities.

E-Business combines commoditisation of products and services with personalisation of them at the sametime. On the one hand, it encourages users to regard many products as commodities varying mainly inprice. On the other hand, it allows more scope to tailor products and services to the needs and tastes ofindividual customers. An energy retailer could choose to focus on commoditisation and drive down unitcosts. Or a retailer could concentrate on a more price-insensitive market segment and differentiate throughpersonalisation. With e-business both are fast becoming a reality.

The low set up cost of most web-based applications, however, means it will be easy, cheap and quick forcompetitors to duplicate any successful initiative, thus limiting any long term competitive advantage.



Figure 2: New Channels to Consumers

Combining “new media” and “old channels”

Source: PwC Consumer Electronic Access Study, 1998.

Many different players can

potentially retail energy

E-tailers

Incumbents

Gatewaysand portals

Affinitygroups

Networkproviders

Insurance

Specialistretailers

Brokers

Brands

Telecoms

Banks

Other newentrants

Customers

BrokerAffiliation

New mediaroutes

Retailer Directsales

C

H

A

N

N

E

L

S

Retailers

Almost 65% of US homes could be online by 2002, 50% of German consumers by 2003 and 70% of UKconsumers by 2005

2.4 GlobalisationThe geographic boundaries of incumbent energy retailers are being swept aside. Traditional regional ornational monopolies are fast becoming competitors on a global stage.

Energy companies which previously operated as regulated monopolies on a regional basis are fastbecoming competitors in a global arena. The boundaries of energy markets are being swept aside.

For example, Spain’s Endesa has 10 million customers in Spain and another 12 million in South America.Iberdrola has 8.5 million customers in Spain and another 4.5 million in South America.

Cross-ownership in, and international entry into, the Nordic countries has increased significantly. Someexamples are given in Figure 3: Nordic Cross-ownership.

Profit margins have been too low in the German market to entice much international investment.Nevertheless, EdF has bought a 25% stake in EnBW, the fourth largest energy company in Germany.Southern Energy has a 26% stake in BEWAG, the company responsible for retailing electricity in Berlin.Enron has also entered the German market, offering energy trading and generation expertise to municipaland regional companies.

As of the end of 1999 more than $6.5 billion of Australian energy assets were up for sale. Included in thisamount is Powercor, bought by PacifiCorp of the US in late 1995 which, in turn, was acquired byScottishPower recently (AFR 22/12/99). In other global moves in Australasia, three Japanese electricitycompanies are understood to have lodged indicative bids for GPU’s Victoria networks (AFR 6/3/2000),while National Grid has won the right to develop the Basslink cable linking Tasmania with the mainland(AFR 6/3/2000).

There are several drivers behind these global moves. There is the potential to capture and share intellectualcapital in energy trading, risk management, marketing and sales and financing on a world scale.Privatisation has put more energy assets on the market, creating the opportunity to build global enterprisesthrough acquisition. International expansion is seen by some as the way to grow revenue when thedomestic market promises only limited growth opportunities. Others see participating in overseas markets,deregulating before their own jurisdictions, as the way to sharpen their competitive skills before beingcalled upon to defend their own customer base.

“Virtual energy retailers” will combine the spread and enhancement of the Internet to penetrate newmarkets with leading-edge marketing techniques which are easily and quickly transportable globally.



Figure 3: Nordic Cross-ownership

Vattenfall (Sweden) Oslo Energi Vattenfall Vattenfall Oy Ström

Fortum/Birka (Finland) Birka Energi Fortum FortumEnergi A/S

Sydkraft Østfold Sydkraft ElektraEnergi

Statkraft Statkraft/ Sydkraft ScanEnergiBKK

Eastern (UK) Elbolaget Savon VoimaTSM

Preussen Elektra Sydkraft(Germany)

EdF (France) Graninge

Country

PlayerNorway Sweden Finland Denmark

Swedish company Norwegian company

Finnish company Other companies

2.5 Shareholder pressureThe demands of shareholders are having a more dominant influence on newly privatised enterprises.

Deregulation and privatisation are creating dilemmas in the delivery of shareholder value. Capital marketinfluence means that short term financial performance and shareholder value is all important. This was notthe case during the regulated monopoly era where energy companies were driven more by political andsocial objectives.

Shareholders are waking up to the potential impact of competition on energy prices, and share pricetrends reflect this awakening.

In Germany, share prices of incumbents have suffered since deregulation due to pressure on margins andrevenues from strong competition in a saturated market. The share prices of RWE and VIAG haveunderperformed relative to the DAX index since early 1999.

The share prices of Spain’s larger electricity companies fell by about 20% in 1999 due to the expectationof lower industry margins. Union Fenosa was an exception due to its diversified nature, and Endesa hasregained lost ground in 2000 as a result of new initiatives.

In Australia:

■ GPU Inc. has announced it intends selling at least a half stake in its Australian electricity and gastransmission businesses. These assets were recently purchased – the electricity network in October1997 and gas in May 1999. The reported reason for the sale is to fund US share buybacks, cut debtand improve earnings to restore a weakening share price (AFR 22/12/99).

■ CMS Energy has put its half share of Loy Yang Power on the market. Its share price has fallen from$US45 to $US19 over the last year. The main reason for the selldown is weaker than expectedelectricity prices (AFR 16/2/2000).

■ PowerGen is reported to be considering selling its stake in Yallourn Energy after purchasing LG&EEnergy Corp in the US. Speculation about the reasons for the possible sale include Yallourn havingbeen hit by price cutting and the need to boost flagging share prices (AFR 8/3/2000).

As most electricity companies in the Nordic countries are publicly owned, share prices, per se, are not anarea of concern. The value at risk of these municipally-owned companies, however, is becoming muchmore prominent. As the market has become more competitive, municipalities have incorporated theirelectricity businesses into public limited liability companies to reduce their exposure. Also, awareness ofthe value of these companies has led to the introduction of ROI performance measures; previously theconcern was more about keeping prices low, supply secure and local employment high.

Companies must be able to convince capital markets that they have clear strategies to succeed – coveringderegulation, convergence, competition and the Web – if they are to avoid falling share prices.

2.6 In conclusion…Energy retailing competition will intensify and market pressures will concentrate. In so doing the balanceof power will shift from supply- to demand-side. Incumbents will have to transform their cultures,capabilities and skills if they are to compete successfully.

Consumers will increasingly buy energy in the same way they buy other products and services today. They will be attracted to one-stop shopping provided by retailers creating innovative market spaces ofcoherent offerings.

If incumbents are to succeed, perhaps even survive, they will have to transform their cultures, capabilitiesand skills, most noticeably in the areas of marketing, sales, customer relationship management andcustomer care. A quantum shift of culture will be paramount, from an engineering and process focus to acompany-wide fixation with customer relationships and marketing. Incumbents will initially have the addedchallenge of having to play “catch-up” to be able to compete with “best in class” new entrants. The challengewill involve future strategic positioning, the development of new capabilities and increased efficiency.

Value, service, convenience and branding will be drivers of success among a new breed of energy retailersoccupying more comprehensive market spaces comprising energy and, perhaps, financial services, telecom,media and other products and services. They will practice dynamic customer segmentation, be masters ofidentifying and exploiting new channels reaching different customer types and will actively implementleading edge technological developments. The key sources of competitive differentiation will be valuepropositions, delivered service levels, flexibility, reliability, time to market and low cost.

Energy companies will need to build sound investor and analyst relationships and convince capitalmarkets that they have clear strategies to succeed if they wish to avoid lower share prices.



3. Future Energy Retailing Trends

A new industry taxonomy is emerging as a result of further fragmentation of theindustry value chain. Players will specialise in different parts of this new chainand expand horizontally. Those in retailing will enhance their segmentationcapabilities and skills and execute marketing strategies tailored to the needs of profitable market segments. Within retailing, the Internet will give rise to anew form of competition, called “e-tailing”.

3.1 A new taxonomyThe forces shaping the energy industry – deregulation, convergence, e-business, globalisation and capitalmarket influence – will combine with continued regulatory pressure to further fragment the industry andbring about a new energy taxonomy.

The forces of change discussed in the previous section of this report will combine with continued regulatorypressure to further fragment the industry (see Figure 4: The New Energy Industry Taxonomy). As the futureenergy industry fragments, enterprises will focus on one or more parts of the new value chain.

An incumbent may choose to perform one or more of the new energy value chain roles depending onperceived core competencies, risk appetite and preferred market focus (consumer segments served,channel-mix adopted, product and services offered and regional/national/global concentration). They willneed to unbundle then re-structure their activities to ensure single-minded focus on their chosen futurebusiness model. The depth of specialist competencies required to meet consumer expectations andcompete successfully will require incumbents to re-invent themselves in a revolutionary, rather thanevolutionary, manner.

Figure 4: The New Energy Industry Taxonomy

Middle MarketMiddle Market

Metering DataService Provider

CustomerServiceProvider

BillingServiceProviderMeter

Owner

MeterMaintainer

Fuel

Sou

rcin

g

Gen

erat

ion

Tran

smis

sion

Dis

trib

utio

n

Retaile

r

Energy Trader/Marketer and Capacity Broker C

HANNELS

I&C

Middle Market

Mass Market

The energy value chain is fragmenting further…

…as a result of:• Deregulation, competition and technology• Different energy company models through specialisation and focus• Emerging national, multi-national or global aspirations of companies

3.2 Specialisation and focusTraditionally a vertically integrated monopoly, the energy industry will increasingly expand horizontally asplayers specialise and focus. The demands of the new retailing market, combined with the benefits ofspecialising, will drive the separation of retailing activities from other parts of the new value chain.Competition will force those companies choosing to operate in multiple parts of the value chain tobecome “best in class” in each part.

Energy retailing will converge with other forms of retailing and will become much more competitive as the marketing and customer relationship management skills of major retailers are brought to bear on theenergy market. Hence, incumbents will need to think about the strategic direction of unbundled retailactivities such as:

■ Front office – customer relationship management and energy product building; and

■ Back office – customer contact service provision, billing service provision, metering data provision, and meter ownership and maintenance (see Figure 4: The New Energy Industry Taxonomy).

In the future, specialist service providers, be they new entrants or incumbents who have elected to pursuea service provider business model, will provide back office services to the front office players. Germanyhas seen the emergence of specialist service providers such as Techem (metering and billing) and BrunataMetrona (district heating, metering and billing). In the Nordic market there is, for example, Etrem andEnermet. The former is owned by, inter alia, Fortum, Birka Energi and Trondheim Energiverk and providesmetering, billing and data transmission services. The latter, also partly owned by Fortum, provides meters,terminal units, comprehensive metering, remote reading and load management services.

In effect, competition and the benefits of specialisation will drive the separation of retailing and backoffice service provision (see Figure 5: The Retail and Service Provision Split). Some incumbents maychoose to continue to provide both office functions, but, at the very least, these activities will beperformed by separately managed profit centres within the single corporate structure. Increasingly in thefuture, however, they will be outsourced to specialists.

The benefits of specialisation coupled with the different cultures, capabilities and skills required to be asuccessful retailer compared to those required to be a successful network service provider, will alsoinexorably drive the separation of these two (see Figure 6: The Retail and Distribution Split).

For example:

■ In Norway, Oslo Energi AS, the largest electricity company in Norway, was split into Oslo Energi HoldingAS and Viken Energinett AS in 1996. The former covers the contestable areas of sales and productionwith about 300,000 customers. In 1999, 49% of Oslo Energi AS (the retail arm of Oslo Energi HoldingAS) was sold to Sweden’s Vattenfall. The latter company, Viken Energinett, covers the regulated monopolyareas of transmission, distribution and district heating and has about 380,000 grid customers. In 1999,the company merged with EAB, purchased 12% of Akershus Nett, and transferred 25% ownership toHafslund – all distributors in Norway’s east. Hence, distribution in the eastern region of Norway isspecialising and consolidating horizontally.

■ In Australia, United Energy, Shell Australia and Woodside Petroleum have created Pulse Energy intowhich United Energy will tip its retail arm but continue to run its local electricity and gas networks(AFR 9/3/2000).

Regulatory pressures may be added to the list of forces driving the separation of retailing and distribution.This has happened in New Zealand and is emerging in the Nordic region, the Netherlands and the UK.

Some incumbents will elect to continue to operate across more than one part of the value chain. Everincreasing competition will demand that these companies become “best in class” in each part of the new



value chain in which they continue to participate. Each line of business may be established as anindependent unit, perhaps even a separate profit centre, within the overall corporate structure.

For example, Lyse Energi and BKK are two of the many Nordic electricity companies that have structuredtheir enterprises according to the structure depicted in Figure 7: A Possible Future Integrated Structure.Lyse Energi on the west coast of Norway was formed by the merger of 17 municipalities and serves120,000 retail customers and 100,000 grid customers. BKK, also on the western coast, serves 146,000retail customers in Norway and Sweden and 145,000 grid customers in Norway.

Figure 5: The Retail and Service Provision Split

Figure 6: The Retail and Distribution Split

Middle MarketMiddle Market

Service Provision

New entrant major brand

retailer

Benefitsof focus

New entrant specialist service provider

BillingCustomer contactRevenue managementLoss preventionMetering and data handlingMastering technology

Retailing

Customer relationship managementBrand managementProposition managementChannel managementPartnership managementCustomer information managementRisk managementProduct and service innovation

Benefits of focus:

• No dilution of management time• Availability of capital• Increased ability to form partnerships with non-competing

companies

Middle Market

Retail

Regulatorypressures

Different businesscore competencies

Distribution

3.3 SegmentationSuccessful future retailers will be proficient at market segmentation and identification of profitablesegments. Retailers choosing to serve the large end-user segment will provide specialist services tailored tothe needs of geographically dispersed, multi-site customers. In the mass market, convergence is likely tosee new entrants to energy retailing, including those with strong brands, proven customer relationshipmanagement skills and advanced Internet applications. Partnering will be used to build coherent sets ofofferings. Margins are likely to be low.

Energy retailing embraces a long list of end-user types – large volume industrial users, commercialbuildings, supermarkets, hospitals, small businesses, government departments and residential consumers,to name a few. When other parameters such as demographics, psychographics, profitability, etc. are alsoconsidered, segmentation possibilities seem endless. At the highest level, however, some retailers willfocus on large industrial and commercial consumers and others on the mass market.

Large industrial and commercial consumers

For these end-users, energy as part of their cost of goods sold ranges from just a few percent to well intothe 10 to 20% range. Wherever consumers may sit in this range, the sourcing of cheaper energy that meetstheir security and quality needs is just too important to their own competitiveness and profits toprocrastinate or hold to traditional loyalties.

In this segment, the popular practice of engaging an energy purchasing specialist and using a tenderingprocess can promote a largely price-driven approach to energy purchasing.

In the not too distant future, energy will be included in e-procurement systems of larger end-users.

Furthermore, specialist services will be required to meet the diverse needs of these consumers. Somelarger industrial sites will have access to on-site or co-site generation. Others possess the infrastructure for


Figure 7: A Possible Future Integrated Model

Retail Business

SharedCorporateServices

TradingBusiness

GenerationBusiness

NetworkBusiness

Market-based transfer pricing arrangements

Corporate centre

• Targets• Financing

Publishedaccesscharges


dual fuel capability. Some are moving to purchasing process steam from an outsourced facilities managerrather than purchase source fuel themselves.

For risk management reasons generators and energy traders will also want to retail to this group. Forexample, generators in New Zealand and the UK have been reconstructing the energy value chain bybuying retail businesses.

Retailers choosing to operate in this business-to-business market segment will develop national,international or global footprints and provide energy products and energy management servicescustomised to individual customers. They will be able to aggregate the energy needs of companies withmultiple, geographically dispersed sites and will provide specialised services such as consolidated billing,dual fuel billing, risk mitigation products and consulting services to improve energy efficiency. They arelikely to acquire the largest consumers of this segment by providing energy products and services beyondthe capabilities of the smaller incumbent retailers.

In Germany, Euro-power has focused on this market segment. VASA, a joint venture between Vattenfall anda German investor, has focused on supplying municipalities with electricity for on-selling. HEW pursuesthe aggregated loads of multi-site consumers and buying groups.

Mass market consumers

A range of new players are likely to enter the mass market energy retailing scene. Incumbents will competeagainst major brand “bricks and mortar” retailers from other markets and also against e-tailers. Examples of potential national retailers in the UK include Tesco and Sainsbury and in Australia, Coles Myer andWoolworths. Global examples include Shell as a major brand competitor and Yahoo!, Amazon and AOL as web-based retailers. These new entrants will compete on value, brand equity, and the ability to deliverthrough channels of choice.

Partnering, in the form of joint ventures or strategic alliances, is likely to be a popular strategy. Very fewretailers, if any, will have the ability to compete successfully across all the products and services of futuremarket spaces. Examples of potential horizontally integrated mass market retailers offering coherentproduct and service bundles include:

■ Utility home products and services companies – energy (electricity, gas, LPG), telecom, home security;e.g. Pulse Energy, Origin Energy, Telstra, Optus;

■ Broad energy companies – energy, petrol, credit cards, loyalty programmes, convenience food; e.g.Shell, Mobil;

■ Financial institutions – energy, credit cards, financial products, trading, loyalty cards, portals; e.g.American Express, Citibank; and

■ Major brand retailers – energy, petrol, loyalty programmes, financial products, retail products, telecom,banking; e.g. Woolworths.

In Germany, switching to Bayernwerk earns 4000 miles in Lufthansa’s Miles&More frequent flyer programme,and RWE and HEW sell electricity through Shell petrol stations.

For risk management reasons, generators will also enter mass market retailing. In Germany, PreussenElektraand Bayernwerk now retail to domestic consumers. Before deregulation they wholesaled to regional andmunicipal companies. PreussenElektra has launched ElektraDirekt to focus on domestic consumers.Bayerwerk has introduced a family of products (PowerPrivate, PowerFamily, AquaPower and SunPower)targeted directly at residential consumers.

The gross margin earned in the mass market is likely to be low, particularly where there is an over-supplysituation, due to intense competition to win and retain customers. Some new entrant retailers may offer

energy products at a loss to aggressively acquire new customers and at the same time build a stronger,wider relationship with their current customers. Significant economies of scale accrue to companies likeEdF and Centrica who already have customer bases numbering tens of millions of households. Leveragingscale and scope to drive down costs to serve, costs to acquire and costs to retain, as well as for competitiveadvantage and differentiation, will be critical success factors.

Unlike many incumbents, today’s successful major mass marketers have already mastered a range ofessential competencies. These include:

■ Strong brands supported by effective marketing to large customer bases;

■ Marketing strategies targeted to sharply defined key segments;

■ IT systems, revenue management and customer service capabilities that are cost-effective and flexible;

■ Coherent product bundles, service offers and pricing delivered with the help of a range of partners;

■ Exceptional value propositions;

■ Flexibility and responsiveness;

■ Strong customer touchpoints; and

■ Increasing provision of self-fulfilment functionality for customers.

Existing energy retailers may not have this full range of skills and capabilities necessary to “go it alone”.They will, however, be sought after as alliance partners by new entrants.

Figure 8: The Future Energy Retailing Industry Structure maps the new market structure that is likely toemerge. Incumbents will be joined by a range of new retailers. Traditional channels will give ground to e-tailing, partnerships with other brands, affiliation marketing, brokers and direct sales.


Figure 8: The Future Energy Retailing Industry Structure

Other high income customersInternet customers "Fuel poor"

E-Tailers• portal sites• gateway providers

Brokers Other brandedpartners

Affilliations DirectSales

DirectSales

Channel

Customer andbrand owner

Serviceprovision

Production

DirectSales

Some of whichwill be vertically

integrated

Non-utilityretailers Service

providers

Otherproducts/services

Wholesaleproviders

Utility retailers


Business-to-Business Energy Retailing: Critical Success Factors

■ Highly capable account management with world class strategic selling skills.

■ The ability to serve multiple sites of large enterprises.

■ A deep understanding of commodity pricing, forward price curves and competitive pricing strategy.

■ An understanding of how to use financial risk and derivative products.

■ Sophisticated information systems to track end-use consumption patterns.

■ Superior energy management and technical support expertise.

■ A detailed understanding of customers’ business and industrial processes, product qualityrequirements and business, including competitive, needs.

■ The ability to find and exploit niches.

Mass Market Energy Retailing: Critical Success Factors

■ A critical mass of existing, loyal customers.

■ Strong strategic marketing skills and capabilities – brand management, segmentation, understandingconsumer needs, creating effective value propositions, accessing profitable target customersegments, creating and shaping end-user expectations and needs, effective new productdevelopment.

■ Strong sales management – channel-mix management and innovation (Internet).

■ Energy supply management capabilities – risk management capabilities, alliance management.

■ Strong supporting infrastructure – CIS, billing, contact centre, etc.

■ Alliance management capabilities – service providers and other product suppliers.


3.4 The rise of e-tailingRetailing barriers to entry are being brought tumbling down by the Internet and new web-enabled technologies.

The Internet enables targeted communications and, when combined with e-business, provides the platformfor serving markets of one. Dynamic customer segmentation is easier and faster. Products and services maybe modified, rearranged and tailored at will. Innovation is almost instantaneous. Far more customerinformation can be gathered and analysed in a shorter time. New energy retailing processes, systems,behaviours and values are needed in this environment, and they are vastly different to traditionalrequirements. The adjustment will not be easy, and partnering may be the solution for many incumbents.

Future e-tailers may be:

■ Incumbents who have reinvented themselves through specialisation and focus. In Australia, AGL hasflagged their intention to develop their Internet and e-business capabilities to leverage their expandingcustomer base in Australia and New Zealand (AFR 3/3/2000).

■ New entrants with well established brands. The Australian Centre for Retail Studies states that almost90% of retailers with revenues of more than $600 million claim to have an e-business strategy (AFR26/11/99).

■ From other industries developing strong Internet competencies, for example banks and financialinstitutions.

■ New, smaller enterprises with an effective web site and a new way to sign up customers, for example,enermetrix.com and nexusenergy.com in the US. enermetrix.com offers savings on electricity and gaspurchases of between 10% and 20%. The company helps customers define their energy contractrequirements, and then over 40 suppliers compete in an auction for the load. enermetrix.com staffmanage the contract documents and the purchase on behalf of customers. nexusenergy.com effectivelyextends wholesale prices into the retail market by aggregating mass market customers up to wholesalesuppliers.

E-Tailers will race to attract and keep customers and, in the absence of differentiation, discounting will bea powerful weapon in the battle to win customers. The Internet enables marketing, sales and transactioncosts to be significantly reduced, thus changing the traditional cost effectiveness equations associated withacquiring and retaining customers. There is the very real possibility that e-tailers will use energy as a lossleader. At the very least, they will encourage consumers to shop around. The attraction of lower prices ispowerful and can significantly lessen the strength of brands and customer loyalty among price-sensitiveconsumers. Under these circumstances owning the customer relationship is difficult.

Looking beyond the immediate horizon, the rise of the Internet could encourage the emergence ofspecialist energy traders appealing direct to large end-users with a single-minded lowest price offer, thuscompeting directly with retailers. The Internet will also simplify the process of forming and transacting withbuying groups, especially those with large numbers. The low cost platform of e-business will be especiallyeffective with residential and small business buying groups because the cost of acquiring these lowvolume consumers is usually a barrier to competition.


3.5 In conclusion…The future for today’s energy retailers will be very different. All will face strong cost pressures and theprospect of low returns. They will focus more on segmentation and implement marketing strategies tailored to segments.

The mass market will segment into Internet users, other high income consumers and the fuel poor.Competitive pressures from new entrants will be felt as multi-product portals serve Internet customers,major brand retailers compete for the other high income "cherries" and the fuel poor continue to attractregulatory controls. Retailers serving the large industrial and commercial segment will operate nationallyand provide energy product and service value propositions tailored to individual multi-site customers.

Retailing activities will separate from back office service provision as well as from network service provision.Retail returns on electricity will probably be low, particularly if used as a loss leader by multi-product new entrants looking to maximise the lifetime value of their customers.

New forms of energy retailing, leveraging broader channel-mixes, are being created. Together withongoing change this will create a risky business environment. To be successful, energy retailers shoulddevelop capabilities to:

■ Gain a deep understanding of consumer needs as the basis for dynamic segmentation;

■ Select profitable target markets and their preferred channel mix;

■ Go to market with unique value propositions that create consumer expectations and shape end-userneeds;

■ Manage service delivery to meet customer needs;

■ Provide the infrastructure to cost-effectively support those needs; and

■ Earn a profit by fulfilling those needs.

Retailing Key Capabilities

Large industrial and commercial customers

■ Competitive pricing structures – as price will be the dominant concern of large end-users.

■ Trading skills and risk management – to keep direct costs down and mitigate risk exposure.

■ Low cost marketing and account management – as identifying and satisfying individual large end-user needs is an important competitive edge, it must be done cost-efficiently.

■ Value proposition creation – as creative contract offerings tailored to individual customer needs willbe the deciding factor under price parity.

■ Strategic and tactical selling – as winning and retaining load volumes will secure scale economies.

■ Energy management services – to deliver “beyond the meter”, value-added services that buildmargins and strengthen customer relationships.


Mass market customers

■ Strategic marketing – as segmentation and effective value propositions will be critical to delivering value.

■ Brand management – as reputation and trust will an important differentiator in open markets.

■ Proposition management and new product development – because the provision of new coherentbundles of products and services will be central to dominating a market space.

■ Mastering customer access channels – as managing and optimising the mix of channels used fromthe plethora of new and existing channels will be a critical success factor.

■ Customer information management – as information is the lifeblood of customer relationships, andbusinesses that are able to meet a multitude of linked customer needs will thrive.

■ Customer relationship management – as customer relationships will be the determinant ofcompetitive power and will be fought over.

■ Trading skills and risk management – as wholesale energy costs account for a high proportion oftotal costs and can be very volatile.

■ Creativity and innovation – as being first to identify and capitalise on market opportunities will beessential ingredients of success in the future.

■ Alliance and partnership management – as few players will be able to do everything themselves.

■ Customer retention and acquisition – as growth in customer numbers will be critical to scaleeconomies and driving costs down.

Service Provision Key Capabilities

■ Customer contact – as every customer touch point is an opportunity to enhance relationships, buildloyalty, broaden services offered and enhance the brand.

■ Transaction handling and billing – as low cost transactions and flexible billing supports innovativeproducts.

■ Revenue management and loss prevention – as reinventing the way accounts receivable arehandled improves cash flow, reduces collection costs, is more convenient for customers andenables profit to be earned in the poorer segments.

■ Mastering technology – the delivery of essential technology is a high reward/high risk area forbusiness.

■ Meter ownership and maintenance – as metering represents a major portion of smaller customers’switching costs and customer acquisition will cause these assets to compete for constrained capitalresources.

■ Metering data management – as accurate, swift communication and efficient storage ofconsumption data is the lifeblood of deregulated markets.


4. Today’s Plays

The ultimate effect of the forces of change and trends discussed in this reportwill be radical transformation. Today’s energy retailers face a very differenttomorrow. Making the right moves now will be essential for success in thefuture. This final chapter outlines seven recommended moves. How companiesview each of these moves will depend on where they are now.

4.1 Choose a final destinationIncumbents will face the hard choice of whether or not to remain in energy retailing.

Incumbents have an abundant choice of future business models and footprints, including:

■ Becoming a world class retailer;

■ Becoming a world class service provider to major retailers;

■ Focusing on local network service provision and divesting retail and other functions;

■ Becoming a fully, or partially, integrated energy company to a defined geographic area;

■ Becoming a world class niche player, operating nationally, internationally or globally; and

■ Exiting the industry altogether.

Choosing a final destination will require a rigorous evaluation of where value can be created andleveraged, the minimum efficient scale of operation, the key capabilities required in different parts of thenew energy taxonomy to be "best in class", and current competencies. There is no single answer, but tryingto be all things to all people will not be an option. Some incumbents may choose to exit those businessroles in which new entrants have unassailable competitive advantages. New partnerships and strategicalliances will emerge. Some incumbents will maintain a degree of vertical integration. Others willreconsolidate.

A clear vision for the chosen business model must be developed and communicated. Execution must thentake place through structured implementation programmes.

4.2 Build a viable brandMany incumbents are starting from a weak position to deliver a winning brand. New “big brand” entrantswill come from retail markets where they already have an established, trusted brand.

Successful retailers will build and defend relationships by offering, inter alia, brand assurance. For example,when considering using the Internet, consumers will look to trusted brands as protection against possiblepoor business practices by unknown e-tailers. An incumbent’s capability to secure ownership of thecustomer relationship by delivering a powerful brand will be key in deciding whether it will be feasible for them to remain in the retailing arena, particularly mass market retailing.

In Germany, EnBW formed Yello to attack the price sensitive end of the mass market. Yello launched with aEuro 60 million brand advertising campaign and achieved awareness levels of nearly 70%. They acquired200,000 customers (Euro 300 per customer). Yello has now moved on to small business end-users.

4.3 Manage the changing cost chainIncumbents choosing to pursue retailing will face a double squeeze on their margins. Prices will fall as aresult of competition, but the demands of world class customer relationship management, brand buildingand new channel development will increase costs.

The squeeze on margins will be heightened by the dynamics of the new energy market. For example, most deregulation analyses estimate that US companies will require IT investment in the range of $US7 to$US12 per customer (META Group 2/00). Our modelling of indicative costs in the UK market suggests thatthe cost per customer can be expected to rise by 10% for companies with a customer base of two million(see Figure 9: Future Retail Business Structure).

At the same time that margins are under pressure from rising costs per customer, they will also besqueezed by falling prices as a result of competition. For some new entrants the race to win customerloyalty will be more important than immediate profits from individual offerings. The lifetime value placedon a customer by some retailers means they could be willing to pay substantial sums to acquire customers,particularly as a result of the growth of the Internet. For example:

■ In the UK:

– Freeserve customers have been implicitly valued at more than £1,000 each (Financial Times15/02/99); and

– Amazon’s customers are said to be valued at £2,000 each (Media Watch 23/04/99).

■ In Australia:

– MCI acquired OzEmail customers for a reported $1,500 each in 1999; Telstra attempted to buy partof this customer base for about $1,100 per customer (AFR 11/1/2000); and

– The price paid by AGL for ETSA Power is $240 per customer, which is in line with similar sales inNew Zealand (Electricity Supply Newsletter 24/1/2000).

Retailers looking to deliver profit margins from a single product will be at a distinct disadvantage to rivalsbuilding multi-product relationships with customers, as the latter will have a greater ability to recoupacquisition and termination costs, reduce churn rates and spread service costs (see Figure 10: CustomerLifetime Value).

Figure 10 also illustrates two of the four drivers of customer profitability; first, the cost to acquire andterminate customers and second, the length of time a retailer retains a customer. The other two drivers are how a customer pays and how much call centre and other staffing resources a customer consumes.Future state-of-the-art customer relationship management systems will measure, analyse and report onthese four drivers of customer profitability.



Figure 9: Future Retail Business Structure

Figure 10: Customer Lifetime Value

Reasons for Increase/Decrease

Other (mainly accomodation)

• Back office and call centre accommodation

• Introduction of “home working” call centres

Customer IS

• Systems will require significant additionalfunctionality (telecoms’ experience)

• Increase in system replacement rate

Call Centre and Back Office

• Internet self-service systems reduce costs

• Managing non-conformant customers

Marketing IS

• Increased data management is critical toeffective marketing and efficient customerservice

Sales and Marketing

• Develop retailer relationships

• Link to portal Web providers

• Investment in Digital TV links

• Develop strong alliance partnerships

• Increased advertising to strengthen brand

Purchasing

• Future ability to pass through costs curtailed

Existing RetailBusiness Structure

Future RetailBusiness Structure

Purchasing

Sales & Marketing

Marketing IS

Postage

Customer IS

Trading IS

Other (mainlyaccommodation)

Call Centre & Back Office

Purchasing

Sales & Marketing

Marketing IS

Communication

Customer IS

Trading IS

Other (mainlyaccommodation)

Call Centre & Back Office

Indicative costs based on 2 million customers, excluding metering and separation costs, through PwC analysis of Gas and ElectricitySectors. ± 20% Confidence Factor in figures. Future supply business structure also based on 2 million customers.

Other products and services:

• Coherent fit with energy

offerings

• Add margin

• Add value to brand

Retention through:

• Developing lifetime offerings

• Focusing on unlocking the

value from customer

relationships to reduce churn

• Offering additional products

to help to reduce churn

Loss transactionscosts

Margin onother

products and

services

Energy retailmargin

Year 1

Winningcosts

Acquisitiontransactions

costs

Year 2 Year 4Year 3

4.4 Capture scale and scope economies Cost chain pressures and price competition will force retailers to identify and execute strategies foreconomies of scale and scope.

There are three ways to deliver these economies: convergence, horizontal integration and vertical integration.

The vertical integration path may have strong attraction to some as inefficiencies in wholesale markets maystill exist. However, continuing regulatory reform and the building of new generation and productionassets will cause these markets to become more transparent and competitive, significantly lessening thereturns from this strategy.

Horizontal integration and convergence hold the most potential for sustainable competitive advantage.Our modelling indicates there are considerable economies of scale to be achieved by growing thecustomer base through horizontal integration. Modelling in the UK market suggests the critical thresholdcustomer base will be at least 4 to 5 million. In Australia, modelling indicates the range is 1.5 to 2 million.Several Nordic players have expressed the opinion that a minimum customer base of 1 million isnecessary to operate efficiently.

There are also significant economies of scope to be realised through using shared services when retailingmultiple product offerings, particularly when large investments in marketing, sales and brand building arealso avoided. Widening scope can create more effective relationships through building confidence,enabling more attractive payment terms and providing more opportunities to gather information oncustomer behaviour and preferences and, hence, better understand their needs.

Low-cost aggregation of small volume customers through technology, marketing savvy or a powerful brandwill be a key ingredient of tomorrow’s leading energy retailers.

4.5 Build new core competenciesSuccessful energy retailers will focus and build core competencies in the key areas of technology enabledcustomer relationship management, marketing, selling, customer care and risk management.

The key characteristics of successful retailers will include:

■ Early customer relationship building – being the first to develop strong relationships with customers,particularly through creating new market spaces;

■ Rapid deployment of new technology – to capitalise on new markets and cost reduction opportunities;

■ Loyal customer base – retaining a critical mass of customers, with effective cross-selling and up-selling,will be essential for all but niche players;

■ Effective and efficient customer acquisition – finding cost-effective channels to acquire targetedcustomers coupled with low acquisition costs;

■ Focus – single-minded attention to the chosen business model to deliver lowest cost world classcapabilities;

■ Brand and offering coherence – a strong brand combined with coherent and innovative product andservice offerings to straddle consumer segments to win new customers;

■ High quality/low cost customer service – the quality and cost of customer service functions are critical,including delivery by third party service providers; and

■ Effective risk management – the effective management of trading and other business risks will be vital.



4.6 Revolutionise and energise the organisation

The competitiveness, complexity and innovation demanded by the new multi-channel, consumer centricmarket will require restructuring the organisation to free business units and deliver focus. There must be arecognition of where to transform radically, and where to substantially add to, the capabilities of the company.

The challenges of managing products and services, pricing, brand, customer relationships, multiplechannels, new technologies, competitors and regulatory change are too multi-faceted to be addressed bytraditional structures. Mechanisms should be put in place to deliver clear accountability. The right movesshould be made to successfully transform internal cultures.

The right strategic management team must be in place to actively steer the company in a new direction.Obtaining the right level of vitality, competence and confidence in key management positions will bedifficult. Furthermore, continuing volatility will necessitate a significant proportion of managementcapacity be available for future changes in the business environment.

There will be a heavy onus on changing the skill mix and culture of the company. Customer orientation,risk management, creative and entrepreneurial skills will command a high place in retailers of tomorrow.Time is of the essence because new entrant competitors already have the right cultures and skills.

4.7 Leverage new technologyRetailers will capitalise on existing and new technology to strip out costs, remove customer barriers andcreate competitive advantage.

New channels for customer interaction have the potential to remove costs and empower customers withcontrol and choice. In this new interactive world, traditional call centres may become a blockage betweena company and its customers. Future retailers will invest in IT to enable customer interaction and eliminateunnecessary administrative processes.

The understanding and use of new technology opportunities will create ways to leap-frog competitors anddeploy faster, cheaper and better ways to do business.

5. The Way Forward

We can help you map and implement your future strategic direction. Whetherformulating your regulatory game plan, helping with organisational design, orcreating new capabilities, we are able to work alongside your team to deliver amore effective and efficient organisation.

Our industry-specific solution sets, coupled with our skill at tailoring these to each company’s uniquecircumstances, enables us to provide the full range of services required to implement change in yourorganisation – from strategy through industry best practice, performance management, process andsystems blueprints to systems implementation:

■ Business transformation – delivering the strategic insight to help you decide your “end game” andachieve it. This embraces strategic advice, market and economic analysis, value analysis, mergers andacquisitions and post merger integration.

■ Competitive market implementation – establishing rapidly and efficiently the entities to make yourcompany an effective competitor. This includes the arrangements for full retail competition.

■ Retailing – helping you decide on your retail focus and build new retail capabilities to match best inclass retailers in other sectors.

■ Customer care – delivering the solutions to managing your customer relationships and billing throughin-house development and/or outsourcing.

■ E-Business – helping you develop your e-business strategy to exploit the opportunities offered byInternet technologies – whether it is getting closer to customers, ensuring the security of transactions or streamlining your procurement processes.

■ Corporate support – benchmarking and improving the efficiency of corporate support functions, suchas finance and human resources. This includes acting as a primary outsourcing provider.

■ Trading and risk management – helping you establish a trading function, determine risk limits and theappropriate risk management policies, select and implement new trading systems and assure theirongoing effectiveness.

All our solutions draw on our wide experience in global markets and are tailored to match individualclient needs.




Project Sponsor: John Fish

Project Manager: Jeremy Apsey

Team Members: Maina Furre Swedberg, Rolf Weber, Cynthia Gladieux, Murray MacFarlane and Enrique Simon

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