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< How can utilities outperform their regulatory settlements? | Multiple challenges in store for water 2010-15 >
Out with the old: power networks need new cost control methods
Network design needs to cater for smart grid and distributed generation
Electricity distribution companies will not be able to deliver the efficiencies demanded by 2015 without radically rethinking how to control costs, say Howard Forster and Mark Horsley.
With the dust now settled on the distribution price control review, the time has come for distribution network operators to execute their plans to deliver the operational efficiencies, customer service standards and capital expenditure programmes they signed up to. For some, this is going to take them into unchartered waters.
Ofgem has firmly laid down the gauntlet for companies to deliver efficiency savings from day one, refusing to provide glide paths as used in previous reviews.
In an exceptional period of financial instability, shareholders and investors in regulated utilities are going to demand cost certainty and improved efficiency. Management teams are going to be under the spotlight to ensure they deliver. It is fully recognised that the sector has exceptional engineering skills at its disposal, but this alone will not be enough to meet the performance challenge needed.
New design challenges
Added to this is a demand for new thinking on new-build power network design incorporating sophistication to address the supply and demand balance to facilitate the implementation of smart grid technology and the connection of significant distributed generation both on and offshore. These are unprecedented times for the industry, with a great deal of the future success for a low-carbon UK economy relying on the energy infrastructure being planned and built today.So in every sense, one pound lost to inefficiency is a pound of opportunity lost for both investors and customers.
Over the past 20 years, the sector has made huge step changes in improving efficiency. A number of strategies have been tried, from totally outsourced models, to forming strategic alliances, to keeping service provision in-house. As with all business models, there are positives and negatives of each, but no "silver bullet" solution.
The real question is, can the sector make the next step change purely through the tried and tested techniques of resource rationalisation and supplier price reduction? Now is the time to reconsider what the potential solutions are, and what are the key factors to ensure these succeed.
Leaders and laggards
Work undertaken by EC Harris estimates there is up to 30 per cent difference between upper quartile and lower quartile performance on capital delivery in the utility sector.
Further detailed analysis indicates two-thirds of the demand-to-build cycle is spent in feasibility and design. There is therefore potential to decrease costs significantly at the pre-build and commissioning project stages.
This insight has led a number of organisations outside the utility sector to explore alternative, lean models that drive out duplication and waste, and deliver efficiencies in these processes. The oil and gas and aviation sectors are driving the frontier with "cost to serve" efficiency levels beyond those that are best in class in utilities. These companies use commercially-led programme management business models that have integrated programme controls with world-class commercial management capability.
Fundamental review needed
There is a need in the utilities sector for a more fundamental review of operating models and processes. Supplier price reductions and concentration of onsite delivery efficiency in isolation will not deliver the required step change.
Moreover, new business models will need to be implemented quickly if they are to affect the full review period. A number of companies have already undertaken business process reviews in anticipation of the review outcome.
Commerciality crucial
It is essential that there is a commercial framework at the heart of these models to add rigour and justify engineering decisions and processes. This equally applies to the customer-facing parts of the organisations, such as new connections and fault management.
Some companies have developed alliance frameworks to deliver increasing capital programmes. Executed correctly through commercially-led programme management, these could provide significant savings through the removal of duplication and alignment of strategy between the client and supplier. Again, we have found in a broad range of sectors that one of the key underlying success factors has been the creation of a commercial entity for the client to strengthen its in-house engineering project management expertise and cost delivery certainty.
The one common theme that pervades the whole sector is the absolute requirement to deliver cost certainty in all activities, across the asset life cycle. This means having accurate cost data and robust cost control processes in place throughout the value chain.
When an investment decision is made and funding is secured, in either capital or operational activities, it should then be delivered for that amount. There should also be gating processes throughout the programme delivery journey to confirm that is the case. The timings and interventions will be driven by the nature of the work.
Decision gateways
Leading edge companies also have in place clear decision gateways to evaluate options against the initial business case, aligned to the overall asset performance improvement plan. They have clear programme and project level governance, enabling them to get it right first time, set against clear asset performance and commercial imperatives.
As far as the workforce is concerned, the sector is heading toward a resourcing cliff edge, with workforce renewal required both within the companies and the service provider community. The sector needs to ensure it has the skills and capability needed to deliver the cost certainty its owners and shareholders require.
This renewal will provide the opportunity for businesses to shape their future operating models and supply chain strategies for the next generation. The reshaped models will need to assess their needs in terms of achieving a balance between engineering and commercial expertise to drive change throughout the operation.
Utilising resources
Utility sector analysis also suggests that in certain cases, companies that have opted for an outsource option to undertake a large proportion of their capital programme fail to fully address their existing internal resource utilisation. This in effect creates an increase in indirect costs or an under-utilisation of direct labour. The successful exponents of outsourcing models have carried out detailed capacity and capability planning in advance, and have defined a delivery strategy that maximises the output from internal resources.
This review is not just about the next five years, but also about balancing the expectations of investors and customers in the longer term. Ensuring all the value levers throughout the business are operating at their optimum level will be essential if those expectations are to be met.
Howard Forster and Mark Horsley are partners at EC Harris.
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