Customer First

Customers are coming to the forefront in the utility industry, driven by technology and a greater desire to be in more control of areas that affect their daily lives. Changing customer expectations are changing the role of the utility. These changes at first might appear incremental if viewed through individual offerings or applications, but in reality they represent a transformational shift for utilities and the industry overall.

In today's always-on digital world, customers have become more demanding - and to some extent less forgiving in terms of how they expect to interact and engage with companies. For utilities, the change in customer expectations is affecting almost all facets of their business. This can be seen today through the range of communication channels that customers are requesting and that utilities are offering, as well as the proliferation of energy management tools and data in the hands of the customer; growth of renewable energy and environmentally friendly offerings; and increasing emphasis on system reliability - which in some cases is driving more customers to think about ways to reduce their reliance on the grid, but still requires utility assistance.

The challenge of serving today's customers increasingly conflicts with one of the basic tenets of the traditional regulatory compact, namely, all customers will be treated with the same level of service regardless of need, expectation, or cost to serve. Today's customers expect service on their terms, and are using a host of new technologies and channels to make sure their needs are met on a real-time basis. In short, there's no monolithic customer that follows the traditional regulatory definition, but rather highly motivated and empowered individuals that expect service and choices that align with their individual preferences.

Changing customer expectations are putting pressure on regulated utilities to expand their role beyond the traditional boundaries of providing the infrastructure that generates and delivers energy. Products and services are taking on a greater role within the industry, but herein lies a fundamental challenge. Utilities today still make money by making capital investments in their business, adding more generation, more pipes and more wires - or a subset of the three. What customers are now expecting from utilities, in general, isn't what drives revenue and earnings for the industry. Moreover, even as customers are expecting - and even demanding in some cases - new services and offerings that represent additional costs and investments by the utility, regulators and many consumer advocates are ratcheting down utilities' allowed rates of return. More pointedly, the traditional rate-base investments that produce regulated utility earnings don't fully satisfy the expectations of all customers.

The traditional regulated utility business model is unsustainable, because there's a growing disconnect between what customers want from their utilities (and hence what utilities must invest in) and how utilities concentrate most of their investment capital. There's a misalignment between the current regulated financial model and the role utilities are expected to play today and going forward. Why is this the case, and what can be done to address it?

Changing Demands

In general there's a greater expectation on the utility to provide customers with more options to control their energy usage and to provide more transparency into how the utility operates. Increasingly the industry is expected to become more proactive than reactive in engaging and interacting with customers. This change is being heavily influenced by individual customers' experience and interactions with companies from other industries.

Today, serving the customer as a regulated utility means not only providing highly reliable service in delivering the commodity (which customers appreciate only when it's absent), but also expanding the portfolio of products and services to assist customers in managing the use of that commodity, and being the backstop for products from third parties that affect the delivery and use of the commodity (e.g., small-scale distributed generation, energy data requirements, and metering equipment).

Industry research indicates that customers want more control over their lives. They expect interactions to be easy, and they expect to be able to interact with any provider the way they want - such as with mobile devices and social media. Technology has created an expectation of always-on, always-available when it comes to interacting with any provider, utilities included. With growing emphasis on technology in today's society comes increasing expectations around reliability. Power outages that once were considered short can now seem like an eternity for some customers, given the disruption they can cause in both their work and personal lives. Customers increasingly expect the utility to provide more information around how they use energy, and more tools and programs to assist them in managing their energy more effectively.

In addition to meeting their obligations to provide safe, reliable, and affordable service, society increasing expects utilities to assume the responsibility to promote and deliver energy efficiency and conservation programs to customers, so they have an opportunity to more effectively use energy. But the question that follows is how to fairly compensate utilities for delivering on these increasing expectations. For example, should regulated utilities have mechanisms for earning a return for all services provided to customers - for example, demand-side programs, operations, and services, versus only capital investments under today's model?

Customer expectations are continuing to evolve and to be more demanding. The utility industry is starting to understand the importance on placing greater emphasis on managing and valuing each customer interaction; on the importance of the overall customer experience and the effect this has on the success of the utility across all facets of its business.

Something likely needs to give; either the role of the regulated utility needs to be more clearly defined to fit within today's regulatory construct, or the regulatory construct needs to adapt to the changing role of the regulated utility. Does the current regulatory model create the right playing field to provide utilities - and third parties - the opportunity to succeed in this new customer paradigm? Or is the current regulatory model unsustainable, creating a growing disconnect between what the customer wants and what the utility can provide while still remaining economically viable?

Because if it doesn't give on the side of the regulated utility, then it will on the customer side through partial exit, e.g., municipalization and greater adoption of distributed energy.

Regulated Evolution

For those that have been part of the utility industry for most of their careers, it's hard to deny that the industry is experiencing shifts across the different facets of its business more dramatic than it has seen throughout its history. Smart grid is becoming a reality; consumer technology is creating new opportunities along with rising expectations. New programs and services are on the rise to address customers' expectations for more ways to manage their energy costs. However, even with all of the changes, the basic paradigm of the regulatory compact remains essentially unchanged. That paradigm by design exposes utilities and their investors to regulatory lag. And for the most part, this paradigm doesn't allow a regulated utility to earn a return on the investment in services - not assets, but services.

In the not-too-distant past, that construct was OK - at least the part of the construct that relegated utilities' returns only to physical assets. However, the advent of smart grid technology, combined with the power of smart, mobile devices and changing customer expectations, is shifting the value proposition away from the standard and important physical infrastructure to services, not things.

Traditionally, for most utilities, customer operations and offerings generally have been treated as a cost rather than a business opportunity. Now, it's increasingly clear that customers and their varied preferences are important parts of the future of the utility business. In addition to being potential producers of distributed generation, customers can be partners with the utility to better manage energy and aging infrastructure.

There's little argument that customers won't sit idly by if rates continue rising and utility service remains the same or even deteriorates. Further, customers won't remain idle even if reliability increases but utilities don't address their broader range of service expectations. Therefore, the question is what should be done to create a level playing field to allow customers, regulated utilities, and third parties to all have the opportunity to succeed in this new energy paradigm?

The current financial model for a regulated utility is a cost-of-service model. It's centered on capital investments utilities make in the business, and the rate of return the utility is allowed to earn on those investments. The day-to-day operating costs associated with running the utility (e.g., operation and maintenance costs) are treated as pass-through costs in this model. The fundamental question is whether this financial model is broken, especially as utilities are being asked to provide services to customers that extend beyond the current boundaries of the traditional regulated utility business model.

The industry seems to be chiseling at the edges right now.

For example, if non-regulated service providers can have customer-authorized access to the information derived from installed smart grid assets, and then use that information to create valued services for which some customers are willing to pay a premium, why can't the utilities that installed the assets use the same information and sell similar services to earn a return?

Decoupling is one model that has been explored as a way forward. This might work for a while in regard to protecting utility revenue, but it does little in and of itself to improve the customer experience, and does even less to facilitate the growth of revenue and by extension earnings. The challenge remains.

Are there other models in the market that better address the changes the regulated utility industry is currently facing? For example, does public power offer any answers, based on how public utilities address today's dynamic and demanding landscape for providing system infrastructure as well as programs and services to customers?

Has something fundamentally changed within the utility sector that affects the value of the traditional utility business model?

The role the regulated utility is being asked to play today, and going forward, is different from the one envisioned when the current regulatory construct was put into place. Policymakers are considering how utilities can extend their role, starting from managing and providing sources of generation to providing services that extend beyond the meter for the customer. As these changes are occurring, there's a growing misalignment on how best to compensate the utility for this new role. The traditional model places value on infrastructure investment and reliability; these attributes haven't changed. However, extending the utility's role places stress on this model.

Several external factors are affecting the utility business model - technology, both in terms of how utilities operate and the interactions they have with customers and stakeholders; changing and growing consumer expectations; the effect of third parties converging on the industry and offering services that compete with utilities; and government policies regarding energy and climate change.

When one looks across the utility industry, it's easy to see changes affecting today's regulated utility business model: rising prices, growing expectations for reliability and service quality, lower load growth due to energy efficiency improvements, growth in renewables and distributed energy resources, tighter environmental regulations and the associated costs, and the desire for more discrete information to better manage consumption and ultimately better control the cost customers pay for the service. When the utility is unable to put iron in the ground or make other large capital investments, and it earns lower returns for higher risks, the business model clearly is unsustainable.

In general the industry operates under the premise that all customers should be treated the same; the model doesn't allow for true differentiation amongst customers and the unique preferences they want addressed. When it comes to serving a diverse set of customers, utilities are constrained by the inability to truly differentiate in ways that customers today are accustomed to seeing in other industries. Adding this challenge with the inevitable lengthy regulatory process to approve most any type of program or service being offering to the customer, and the effect is a lack of timely innovation on the part of the industry to truly address customer expectations.

These factors are creating a growing gap and increasing friction regarding how utilities should earn a return on all of the services they are expected to provide to customers. There's an intense tug a war taking place, between the role of the regulated utility and the current regulatory construct - with the customer caught in the middle.

Updating the Model

If change is inevitable, can utilities and regulators successfully manage the expected challenges ahead under the current regulatory paradigm and utility business model? If so, for how long? In other words, is the utility model threatened or does it just need tweaking?

The pace of change in the industry from internal and external forces is pushing the regulated utility to extend its role beyond the boundaries that the traditional model was designed to support and compensate. The gap is growing, and putting increased pressure on utilities' resources and financials to meet these growing expectations.

In the short term, the changes needed to address this misalignment might be incremental, but in the long term these changes will be transformational due to the changing role of the customer in the energy equation. Today's regulated model can't successfully resolve the increasing tension between utilities, customers, regulators, and other stakeholders on how to balance demands across all parties. Other parties could fill voids created in the industry as decisions are made on how to proceed, creating further uncertainty on what the model should look like.

What are the potential consequences if the utility business model completely breaks down?

Rarely is there an issue in the utility industry that has dramatic effects overnight, and this issue is no exception. However, as many analysts recently have observed, inaction, or maintaining the status quo, could well have negative consequences on the industry's financial performance. That leads to underinvestment, declining service levels, and reduced reliability - a vicious cycle that takes time to develop and then to stop.

We also have seen that financial turmoil, whether in the utility industry or other industries, leads to highly politicized events and high-stakes drama that impedes the ability to make reasoned decisions.

No matter what happens, meeting customer expectations and serving customers should remain the industry's top priority, irrespective of the regulatory construct and business model of choice.

It's still early in the game, but these developing trends are rising in importance among utility executives and in boardrooms across the industry. There's a high probability that some states and utilities will lead the charge with some version of a new model - most likely incremental and not transformative all at once. However, a series of incremental steps ultimately could become transformational.

An alternative scenario could be for utilities to struggle to preserve the status quo, engaging in a series of conflicts that produce small wins and losses in the regulatory process. Ultimately this will create more tension between utilities and regulators, leaving customers stuck in the middle.

Transformation is required to serve customers today and in the future. The discussion needs to continue across all stakeholder groups to identify ways to create a level playing field where all parties have the opportunity to be successful. Customers deserve nothing less.