For much of the past century, the electricity and natural-gas sectors of the United States, as in most developed countries, appeared stable, prosperous, and relatively unexciting, at least from the outside. But in the mid- to late 1980s, a massive industrial restructuring got under way as corporations scurried to position themselves for the coming era of deregulation, volatile energy markets, and intense competition.

Dallas-based TXU, the product of a three-way operating-subsidiary merger in 1984 (though with roots stretching back to 1882), was among those convulsed by the storm. After the company consolidated its domestic position with a further restructuring (in 1993) and expanded internationally in Australia, Germany, and the United Kingdom, it seemed reasonably well placed when Senate Bill 7 (the Texas deregulation legislation for the electricity industry) came into effect, on January 1, 2002. Yet ten months later, TXU was forced to downgrade its earnings expectations and plunged into the most serious financial crisis in its history.

The subsequent transformation was led by C. John Wilder, TXU’s first “outside” CEO and formerly the chief financial officer and a member of the senior-management team at Entergy. Under Wilder’s direction, TXU’s financial and operating performance have sharply improved, fixed costs have been cut by more than $1 billion, and a new emphasis has been placed on excellent customer service. In 2003, for instance, customers waited an average of four and a half minutes for calls to be answered; by the summer of 2004, the average wait was down to less than 15 seconds.

Above all, TXU has learned to prosper in liberalized markets, as opposed to regulated environments in which the state and federal governments set the rules. The company’s transmission and distribution business (TXU Electric Delivery) is still regulated, but power generation, wholesale distribution, and retail sales—which account for the bulk of TXU’s turnover—have all been liberalized.

Wilder met with McKinsey director Warren Strickland at TXU’s Dallas headquarters. During their conversation, Wilder talked about the challenge of deregulation and the power of managing with an economic perspective.

The Quarterly: What was the initial impact of electricity deregulation in 2002?

C. John Wilder: In a nutshell, the government that had created this regulated industry was saying, “We don’t want to regulate you anymore. Here’s your business. Good luck.” However, the restructuring process initially generated more questions than answers, as the various players in the market tried to understand how the configuration of this industry might need to change. For example, production and marketing were intertwined. Did that make sense or didn’t it? Should we have the coal, gas, and nuclear plants we had then or a different mix? Should we have the same customers? More? Fewer?

The Quarterly: Did TXU have the right knowledge and skills to start answering those questions?

C. John Wilder: A business coming up from regulatory roots generally doesn’t have a firm grounding in microeconomics. Under regulation, billions of dollars of risk is passed on to the customer. So if a regulated entity like TXU spent too much building an asset, the customer generally paid the costs. At TXU we quickly discovered that we had two businesses losing tens of millions of dollars apiece. And no one knew it! That discovery was an early win internally because it woke people up to the underlying economics of the business.

The Quarterly: Presumably, the economics of the business were far from transparent?

C. John Wilder: That’s right. In power companies like TXU, there are multihundred-million- to multibillion-dollar risks that you can’t see. And that can lead to significant underperformance, as risks and opportunities tend to get bundled together and significantly mispriced.

When I arrived, we looked at where the price of natural gas had been over the long term. We calculated that 75 percent of the time, that price was too low to cover our fixed costs. So we had to take a billion dollars of fixed cost out to be confident that the company would survive.

The Quarterly: Everybody at TXU talks about the “38th floor,” where you initiated your transformation project immediately upon arrival. Tell us about that.

C. John Wilder: It’s an old-fashioned project floor, but it turned out to be more than that. When you’re evaluating interrelated issues, it’s critical to have a lot of interaction. We wanted, for example, to have the financial modelers on the same floor as the business teams that were analyzing the various elements of the business. This helped bring some analytical rigor to our portfolio decisions. But importantly, it also helped people understand that we were going to make economically based decisions—which was not a deeply embedded cultural norm in the company.

The Quarterly: How did the 38th floor help create the momentum for change?

C. John Wilder: It’s important to know the first couple of steps of any transformation, and the 38th floor provided those steps. It had action, people, teams, things happening all the time: “Let’s put supply chain teams together.” “Let’s do some quick reverse auctions.” “Pitch your business plan to me. How well can this business really perform?” We were giving people tangible things to work on.

But the 38th floor was also about focus, which is really hard to achieve. Ninety-five percent of the economic rent of a company comes from 5 percent of its activities. The magic is in getting to that 5 percent. And in these highly capitalized companies, you can get there more quickly in a project mode than you can in a conventional organizational mode.

The Quarterly: Have you repeated the 38th-floor experiment?

C. John Wilder: Actually, we’ve really kept it going under different names: the restructuring team, the operating-system team, the corporate-initiatives team, and so on. But it’s the same people each time working on a different set of opportunities.

The Quarterly: You told us that TXU had serious knowledge gaps, but judging by the early restructuring results, you must have filled them quickly. How did you do this?

C. John Wilder: We used a lot of outsiders. We were trying to show people that we value knowledge and experience. So we didn’t care what jersey someone wore. A banker? A lawyer? A consultant? Been with TXU for 40 years? Four days? None of that mattered. It was all about who had an answer for a problem.

The Quarterly: Besides going outside for talent, did you find some people underutilized on the inside?

C. John Wilder: That’s why we ran a “battlefield promotions” exercise. We found managers down in the organization that we could pull up and stretch. One of the first things we talked about was the need for fewer managers, though this wasn’t a cost idea. We knew we had talented people whose jobs could be scaled up and it would be good for them.

I’ve always believed that a good manager part time performs better than a modest one on double time. But not everyone agrees. Some people believe all managers are more or less the same. I think a high-impact manager in the right role can improve performance tremendously. We had a number of positive surprises, and they were all newer managers. We replaced their small jobs with big ones, and they just blossomed.

The Quarterly: How did you decide which senior managers to keep?

C. John Wilder: In my introductory call to investors, I announced that I was the only one of the top 100 or so managers who had a job. I was going to spend the next 90 days making a one-on-one assessment of each one of them and then selectively bringing them on board. For those asked to be part of the team, I asked them to commit to five years working through a tough, difficult turnaround and take a pay freeze in exchange for what I call “turnaround equity.”

The Quarterly: You didn’t run a standard frontline change program, so how did you manage to energize the organization so quickly?

When we did a cultural audit, we found that the number-one complaint was that management was not dealing with employees that everyone knew weren’t carrying their load: “If my coworker is loafing, then he won’t be keeping an eye on me when I’m in the bucket truck. So doggone it, management, if you don’t take him out, I could get hurt.” In an industrial culture, job safety is a strong rallying cry.

The Quarterly: Leaders often focus the front line on customers, but the legacy of regulation must have made that hard to do.

C. John Wilder: Early on we spent a lot of time talking about customers. I’d say, “Listen, we’re not a monopoly anymore. We have to compete for our customers. They have a choice, so now it’s a different business.” But TXU was a nice, comfortable place, and some people liked the way things were. I remember an angry debate I had with some employees about outsourcing IT. They went on and on, and it was all about them. I finally interrupted and said, “Listen, we made this decision for our customers. They deserve better service—like someone answering the phone when they call us. And poor IT execution is behind this problem. So this isn’t about you, or me, or anyone in this room. It’s about the people who buy electricity from us. From now on, this is how we’ll run this business: for the customers.”

The Quarterly: Economics has been called the “dismal science,” yet you used economics to create positive energy in the organization. How did you accomplish that?

C. John Wilder: You have to put things in the context of a business model. Who are your real customers? Can you grow the business? What kind of partner do you need to make the business work? We have sold several businesses. The gas business, for example, was sold to a natural-gas distributor, which is a natural owner for that type of activity. So those employees have a chance for real careers with a real gas company. “That is their core business,” I told them, “so this is the best thing for you. You’re going to be part of the biggest gas distributor in the United States.” Context is important for people: “What do you really do? And where should that work be done?” Or as an economist would put it, “What’s the highest and best use for your talent?” That’s what economics is all about—getting people and businesses to their highest and best use.

The Quarterly: Of course, your managers already had some quantitative skills when you arrived. If they were to think economically, what did they need to learn?

C. John Wilder: Well, for one thing, how to use the back of an envelope—to find the right big direction to move in and to appreciate that calculating to the ninth decimal point just isn’t necessary. Helping people understand this was important in our early efforts. In a meeting I would ask what a proposal would cost us. Someone would say, “Let me get back to you on that.” “No, don’t get back to me! Let’s work it out right here. So let’s see. It would be 20 terawatt hours of production times a 9 heat rate.¹ Assume these gas prices and scale it. Now put it in a perpetuity. Skip the DCF² calculations for now. It comes to $100 million a year of savings, so it’s roughly a $1 billion event.” Maybe it’s really $0.97 billion or $1.02 billion, but we know enough to make this a high priority for further work.

We work hard to build the discipline of testing against a wide variety of outcomes. To teach this, I would often suggest the opposite of what I thought people would be thinking: “Oh, well, I think Australia could be a great business.” “What if margins went to 120? That would make the business worth $3 billion. Are we sure that isn’t going to happen?” I needed to get people to consider outcomes that could make a material value shift in these businesses.

The Quarterly: Some of your economically rational actions are likely to startle and maybe even anger some of your people. Did you use any actions to create what educators like to call a “teaching moment”?

C. John Wilder: Yes. For example, we gave a large bonus to an employee who worked on a very important business initiative, taking a clear leadership role in the project. This leader’s contributions generated real economic value to the bottom line. Of course, news of that raced through the whole organization, but it helped people understand that rewards will be based on contributions and that “pay for performance” could actually be put into practice.

The Quarterly: Some people argue that the economic perspective, for all its power, leaves important things out of the equation—for example, human concerns such as safety.

C. John Wilder: Well, I disagree. Well-run industrial companies are always the safest and the most productive, and they make safety their highest priority. It all fits together as a package. Most people think cutting costs makes you unsafe. My answer is, “No, we’re going to do all of it. We’re going to be safer, cheaper, faster, cleaner, and more productive. Well-run companies do all of it!”

The Quarterly: How do you get people in support roles—not obviously “economic” ones involved directly in value delivery to customers—to see the economic perspective?

C. John Wilder: It is a challenge. For example, attorneys typically aren’t properly zeroed in on the economics of the company. For example, instead of waiting for lawsuits to try, the employment lawyers could ask what they could do to prevent such suits from being filed. It’s such a sensible way to think about that role. They are in a perfect position to intervene. So, for example, if our internal posting system isn’t working properly, it might look like intentional bias. Well, if there really is a legal risk there and the economic opportunity cost exceeds the cost to remedy it, then it makes sense to remedy it.

The Quarterly: Much of your leadership, then, involves helping people to cope with economic realities. It seems everything boils down to numbers.

C. John Wilder: Not quite. For example, people will argue with you all day long about targets, so you have to put them in the context of performance. There’s something so strong about that word. No one wants to be a low performer. “What do you mean you can’t run these plants at top-quartile cost levels? Are you saying you’re not a high performer?” I think focusing on the aspiration for high performance was one of the best things we did.

Many executives in our industry deliver speeches to investors the way some politicians do: they use a lot of platitudes and metaphors. But this is a business, and I talk about it as an economic entity. However, you still have to get people excited about what they do or you won’t get anywhere.

The Quarterly: Many corporate leaders report that they struggle to elicit excitement or any emotion at all in their employees. Was that your experience?

C. John Wilder: Not at all. I think most people are desperate for leadership—at least when they’ve lost their confidence, as TXU had. A lot of the managers started believing they couldn’t do much right. Billions had been lost in Europe; the Australian investment wasn’t doing very well; the gas business was a loser. We were having serious problems in our base business. Customer care was poor. In that setting, people said, “I don’t exactly know where this guy is taking me, but at least we’re going somewhere.”

The Quarterly: So a new leader actually has a lot to work with?

C. John Wilder: In the beginning, yes. For the first six months, you don’t have to get permission to make changes. You get a little slack. “He’s new. Fine. Let him make some mistakes.” But that leeway starts getting smaller and smaller the longer you’ve been around. That’s something I learned in my early days at Shell, where they move you around a lot. After a while, you figure out that you have to hit hard and fast in a new job.

The Quarterly: Is there any sound advice from other leaders of change that you found especially hard to follow?

C. John Wilder: Well, everyone always says that you move too slowly. So much of this stuff, you just know, needs doing. I think we did all right, but we could have moved a lot faster. But of course that’s what everyone says.

The Quarterly: So what about the future?

C. John Wilder: Now we’re on a growth trajectory. We said early on we were not going to grow the businesses until they reached a point where we could declare them to be “high performance.” Now we’ve earned the right to grow. Once a business is performing well enough, we’ll invest more capital in it, and we’ll grow it in other markets.

We’re studying what the growth opportunities might be. And we’re excited about at least one strategy. We’ve launched a generation-development program, beginning with a $10 billion investment to bring nine gigawatts of generation capacity online by 2010, which will ensure Texans continue to have reliable electric supply. And we’ve coupled that with the largest voluntary emissions reduction program of its kind in the United States. We’re also looking at opportunities in other markets and have announced our intent to develop two to six gigawatts of nuclear capacity at one to three sites in the next eight to ten years. We think this strategy has a lot of potential, so we’re trying to reach the same level of excitement, focus, and interdisciplinary work around it that we had on the 38th floor.