Utilities Should Build and Expand Their Core Business

By establishing and expanding its core business model, utilities can begin to take hold of new opportunities in the face of major disruption.
Published: Tue 25 Mar 2014

The goal of every company is to attain sustained, profitable growth and the way in which to do it is to build a strong core business and expand it into close adjacencies.

This is often done by applying a tried and tested “repeatable” business model and then and proactively adjusting the strategy as the environment alters. The core of a business includes a company’s most profitable customers, differentiated and strategic capabilities, critical product offerings as well as the most critical channels.

These assets and capabilities should be identifiable and measurable as this is what will distinguish a successful business from its competitors. It is then up to the management team to preserve and expand its firm’s unique strengths.

Develop core and non-core businesses

In order to profit from the core business, it needs to be properly developed first so that its full potential can be harnessed. Once this has been done, non-core businesses can be tapped into.

Successful utilities today are doing both. For instance, US utility Wisconsin Energy (WE) developed an ambitious 10-year capital investment program for its core utility starting in 2000. WE invested US$7 billion in the utility, while shedding its nuclear plant and other non-core assets. The company also participates in a high growth transmission venture outside of its state-regulated utility business. WE is among the small group of US utilities that have produced an annual total shareholder return of at least 10% since 2003.

Often, utilities think their core is “tapped out” and that opportunities for growth are limited. This is when utilities should explore beyond the core and even redefine it instead of abandoning it altogether.

A good example of this is European utility RWE which understands that the structural changes of the current market environment-especially the rapid, strongly subsidised expansion of renewable energies- has lead to a massive decline in cash flow for conventional generation. In response to this pressure, the utility has made the decision to contribute to the inevitable transformation of the European energy system. The utility is investing heavily in renewable energy and is also selling innovative products and services to remain viable in a highly competitive market place.

British Gas is another good example of this-the utility intends to innovate across its retail portfolio and increase returns through efficiency this year. The firm will be adding innovative products and “enhanced digital capability” will be key to future expansion and retaining existing customers. A new billing system will launch in the coming months and the firm expects growth to come from “the development of new offerings tailored to the most valuable customer segments”. The utilities firm is also looking to carve a point of differentiation around connected homes through its Hive service which launched last September, claiming it as “core to our customer proposition”.

The repeatable business model

It is a mistake to underestimate either the challenge or the value of capturing the full potential of the core.

Many may think that earning a regulated return is somehow less challenging than earning competitive returns in deregulated markets. But, achieving the allowable return requires a “repeatable model” in which a utility masters multiple relationships (including state, regulatory and customer constituencies). It is able to manage its rate-making efforts in a manner that satisfies both shareholder financial objectives and the needs of other constituents, correctly identifies and executes on investment projects, and maintains safe and effective low-cost operations, explains Bain and Company.

Repeatable models, based on a company’s core, are the underpinning of sustained, profitable growth. The ability of a utility to consistently translate multiple constituent needs into successful investments and operations at acceptable rates, repeatedly, is integral to sustained profitable growth.

Investment in close-in adjacencies

The core is the center of a business, but it should also be the foundation for further growth. By expanding the core, growth and profit performance will benefit. By exploring adjacent markets, the core can be extended.

An adjacent market may involve a new product or line of business, a new set of customers or sales channels, or a new geographic region. A close-in adjacency is one that is not too far removed from the core and it involves very little change. For a utility, a close-in adjacency might mean moving from coal generation to gas generation, or expanding from serving residential customers into serving commercial customers. Farther-out adjacencies—moving into gas exploration or processing, will involve greater change, including new customers, new technologies and new competitors.

Yet, any adjacency move is challenging and many fail. The closer it is to the core, the higher the probability of success.

Often the source of adjacency growth for companies lies in their hidden assets—an overlooked capability, asset or relationship embedded within the core which, if positioned differently, could be the source of adjacency growth.

Over the last 10 years, US utilities that generated a total shareholder return of 10% or more all focused on core and close-in adjacency growth.