Disruption in the power and utilities sector
Managing strategic risks
No matter where you sit in the value chain, the message is clear. Surviving and thriving in a rapidly changing power and utilities sector isn’t simply about the importance of demand and new fuel sources, or about regulatory or societal pressures. It’s about envisioning different futures, understanding trends and uncertainties, considering the implications for underlying assumptions in the strategy and the business model, developing monitoring capabilities, and then responding accordingly when disruptions have the potential to upend core beliefs.
Hindsight is 20/20
On June 16, 2013, renewable energy generation in Germany soared to 61 percent of electricity output. The wholesale price plummeted to minus €100 per megawatt hour (MWh). And the supply of energy so exceeded demand that German utilities were paying others to take their electricity.
The repercussions? Significant value erosion, write-offs, investor backlash, and intense pressure on executives to make tough strategic choices about the future. It also signaled an about-face in the utility sector with the German market becoming increasingly, and irreversibly, dominated by renewables. In July 2015, 78 percent of the nation’s power was generated from renewable resources.
The shift that occurred may have been unprecedented. But it wasn’t that surprising. Because the conditions for this industry upheaval were years in the making:
- German utilities had bet heavily on fossil fuels and nuclear energy. But when energy demand didn’t grow as expected, high energy costs pushed both industrial and retail consumers toward self-generation, and widespread protests against nuclear energy prompted the German government to accelerate already-planned closures of nuclear power plants.
- The German government introduced feed-in tariffs to accelerate the investment in wind power, biomass, hydropower, geothermal, power and solar, and other new energy technologies. This growth in renewables became a challenge to utilities.
- The shale gas revolution lowered US gas prices, reduced US coal imports from Europe, and drove down the cost of coal in Germany.
As utilities struggled to deal with events that invalidated their fundamental assumptions of doing business, renewables flourished. June 16, 2013, brought these long-term trends forth with surprising force.
Not “if” but “when”
It’s unlikely that developments in the US utilities sector will mirror what happened in Germany. But transformative forces are already impacting current US power and utilities business models. Some of those forces are trends, like slow growth in demand and customers’ “purchasing” behavior; others are difficult-to-predict uncertainties, such as the long-term balanced energy mix and changing regulatory environment.
As technology evolves, rules change, and stakeholder expectations shift, it’s no longer a matter of if the fundamental assumptions underlying the classic utility business model will change or become obsolete. Instead, it’s a matter of when, how fast, and how big those changes will be.
The pace at which this transformation will occur is uncertain, as are the future roles of various players in the sector. Consider, for example, that some customers have decided to generate their own power, in essence becoming potential future competitors.
The key lies in identifying, measuring, and monitoring signals that may indicate what may come. Organizations that can continuously recognize critical signals, separate those signals from noise, and understand their impact will be better equipped to adapt, survive, and thrive in the “new order.”
Trends driving the world of tomorrow:
- Technology developments
- Consumer preferences
- Customer re-prioritization
- Intervention from federal and state regulators
- Declining demand for electricity
When presented in combination, these trends have the potential to create strategic risks, which are risks to the fundamental business model.
Strategic risks are a priority
At the heart of the traditional approach to strategy lies an important assumption that, by leveraging a set of powerful analytic tools, executives can place informed bets on the future. Conventional wisdom suggests that applying this approach to any business can allow leaders to choose a clear strategic direction and then execute on it relentlessly.
But this approach may no longer be valid, and organizations may find themselves caught by surprise when their bets don’t play out as imagined. This can result from a number of missteps, including underestimating or failing to identify emerging risks, over-dependence on historical data, non-linear advances in technologies and customers’ expectations, falling into patterns of groupthink, heavy reliance on the status quo, or insufficient focus on risk discussions.
In some cases, the speed of new disruptions may simply outpace risk management capacity.
To understand what these strategic risks mean to you, ask yourself these questions:
- What assumptions are you making about the future of the sector? Which assumptions are already being challenged?
- How will you navigate if the industry looks completely different tomorrow? Will you be ready to compete in new ways and with new players?
- How can a 100-year-old company change its business model, culture, and value proposition?
- How much time do you need to change your organization? How much time do you have?
- How can you proactively monitor potential shifts within your fundamental business model assumptions?
What smart companies will do
The challenge for power and utilities executives is to find new ways to adapt to rapidly changing conditions, quickly identify potential threats to their business models and strategy, and spot opportunities as they arise. Fortunately, the tools to help companies survive in a changing world do exist, and risk functions within organizations are well-positioned to support this challenge.
Smart organizations should develop a system to deal with unexpected changes that threaten their business models and the fundamental assumptions behind their strategic initiatives. This system includes people, processes, and capabilities to:
- Accelerate discovery. Today’s power and utilities companies must create regular, systematic mechanisms to accelerate the pace at which they discover sources of surprise.
- Scan ruthlessly. Potential sources of change don’t come with a big sign that says “historical market shift.” Performing trend analysis and future scanning can reveal small, subtle indicators of change across a range of industries and domains that could, over time, produce a tipping point.
- Confront biases. “That will never happen” is the most dangerous phrase in today’s C-suite. No matter how experienced, no leader or institution is immune to biases. Once you admit to those biases, you can begin to step outside yourself to observe them.
- Prepare for surprise. When an emergent risk turns into a strategic threat, it’s too late to study the problem. You must respond with confidence, clarity, and precision.
Discover. Scan. Confront. Prepare. Do it with the best knowledge you can find about the world, your organization, and your team. Great companies recognize that it’s the events they can rarely predict that will reshape their businesses. Standing still is not an option.