In many ways, electric power is the antithesis of a global industry: except for generation, where load sharing across regional pools is commonplace, nearly everything the utilities do is carried out by local players serving local customers. Yet slowly but surely, the electric power industry has started to globalize.

It is the restructuring of electric power through privatization and competition that is giving rise to opportunities for globalization. Changes in the structure of local industry—notably the disaggregation of the vertically integrated business system—will permit companies to specialize in narrow pieces, or "slivers," of the industry. These specialists will quickly recognize economies of scale beyond the "local position" and seek to aggregate horizontally. Consider the reading of electricity meters. In the past, this was just a tiny part of the operations of national or regional monopoly electric utilities, which typically sent workers to read the customers’ meters. But new technologies make it possible to read meters cost-effectively from remote locations. As a result, meter reading has started to become a stand-alone business all over the world; it is being disaggregated from the value chain. Later on, through organic expansion, as well as mergers and acquisitions, a few giant companies will probably aggregate much of the business across the most accessible parts of the globe to create the economies of scale essential to profitability. Coordination mechanisms among these companies will permit them to serve customers seamlessly.

Already, many integrated utilities are treating their different businesses —traditionally thought of as generation, transmission, distribution, and customer service but also including wholesale trading and retail—as fundamentally distinct operations. But a much finer level of disaggregation is likely in the future. An electricity generation business could, for example, comprise separate entities for development, fuel procurement and manage-ment, operations, maintenance, and ancillary services. Retail supply could devolve into customer acquisition, customer service, credit scoring, billing and collections, and call-center support. A service integrator would provide for coordination.

Although the forces behind the process of globalization are strong, they will take time to play out. The sheer complexity of the political and regulatory environment is likely to slow down the pace of deregulation significantly, and the "stranded investment" associated with nuclear plants and other high-cost assets will make transition-era deals very complex. Moreover, electricity is not easily transportable across great distances; unlike many commodities, it (or at least its creation and delivery) will necessarily remain local or at most regional in scope. Thus the "law of one price"—the sign of a single unified market—operates only at the regional or micromarket level, not the global one.

A last complicating factor is the special opportunity the industry offers for building businesses that include but reach beyond the traditional scope of electric utilities. There are, for instance, many obvious synergies to operating gas and electric systems in concert, for these businesses face common challenges, such as maintaining rights of way, managing large-scale engineering and construction projects in urban settings, and coordinating widely dispersed field crews to undertake maintenance and repair. A good case can be made for coordinating not only the replacement and repair of telephone poles with the activities of electric companies but also the laying and repairing of water mains, on the one hand, and of natural-gas lines, on the other. And global specialist companies could read gas as well as electric meters.

Indeed, many composite utilities have already emerged to exploit these synergies. Enron has broadened the scope of its risk management group from gas—its core business—to electricity and, more recently, to pulp and paper. It also acquired Wessex Water as a prelude to extending its development skills into the water business. Puget Sound Power & Light merged with Washington Natural Gas specifically to capture synergies between the gas and electric businesses. Duke and Carolina Power are entering the local telephone industry. Edison International, PEPCO, and several other utilities are forming Internet- and cable-oriented subsidiaries or joint ventures.

In all likelihood, events will move slowly, so today’s players should develop their strategies with an eye no less to the mid game than to the end game. In the foreseeable future, WorldMeter Incorporated and ÉnergieMétrique & Cie. will not become the only meter readers in town—or on the planet—and a great deal of money stands to be made (and perhaps lost) during the long transition to fully competitive slivers. Companies will have to move ahead carefully if they are not to lose power, as it were, during the exhilarating and challenging process of globalization.

The drivers

Four forces will drive the globalization of each link in the electricity value chain: the industry restructuring environment, the need for capital, the need for scale, and the opportunity for management "arbitrage."

Industry restructuring

Privatization and competition are the most important forces behind globalization

The most important force behind globalization is the restructuring of the industry—in other words, the privatization of state-owned assets and the introduction of market forces (as opposed to strict regulation) between the links in the vertical chain. Until recently, in most of the world the industry’s dominant structure of vertically integrated monopolies with limited or no competition made it nearly impossible for global entrants to break into new markets.

Yet successful restructuring initiatives in Argentina, Chile, Scandinavia, and the United Kingdom have made regulators and legislators increasingly comfortable with the idea of breaking up the industry value chain and opening markets to competition. In the United States, where the successful restructuring of the telecom-munications and natural-gas industries made regulators more confident that competitive utility systems could benefit consumers, the early leaders in the restructuring of the electric power business have been the New England states, California, and, more recently, Pennsylvania.

The generation of power has become a commodity production business, selling kilowatt-hours into wholesale power markets. Transmission and distribution continue to be "natural monopolies," though performance-based ratemaking, rather than the traditional cost-of-service regulation, is increasingly the rule. Many (and in some cases all) customers have won the right to get their energy from competing suppliers. The success of these experiments has encouraged other states and countries to follow suit; the members of the European Union will soon pass into law directives that require the opening of a significant portion of their markets to competition, thus expanding the playing field for global sliver specialists.

Countries and regions will restruc-ture at their own pace, and this, as well as the variety of economies and business cultures on the planet, means that full competition will arrive at different times and in differ-ent ways in different places. Yet re-structuring, once started, seems to go on until it is effectively complete, and the authors do not believe that na-tions will halt for long at some inter-mediate stage.

In fact, it is useful to think of the electric industry as the proverbial slippery slope, with only two points of stability (see exhibit). One, at the top of the slope, is the fully integrated monopoly electric system character-istic of countries like France. The other is at the slope’s bottom, with full competition both in generation and supply. Some argue that there may be a stopping point in-between, where independent power producers and wholesale competition coexist with integrated utilities and regulated retail service. Although the United States has followed this model since 1978, we believe that it will prove to be unstable and slippery, as it has in that country.

Within ten years, we expect that the world’s major economies, with few exceptions, will have made significant strides toward opening their markets to competition. By then, most if not all of North America and Europe will have fully competitive systems.

The need for capital

The second major force promoting globalization in electric power is the huge need for capital in many parts of the world. High population growth, coupled, until recently, with rapid economic expansion, has overburdened the electricity systems of many developing countries. Strapped for the cash to support the level of investment required, many of them have been pushed both to deregulate their electricity markets and to create a business climate attractive to foreign companies.

Such considerations explain why the businesses that have globalized most quickly have been those with the greatest need for new funds. The develop-ment of additional resources for generation, which will absorb almost two-thirds of the incremental investment of $2.3 trillion¹ in the electric power industry through 2010, is already global; the vast majority of the business has been won by a handful of independent global power producers, including AES, Enron, National Power, and PowerGen. Distribution, accounting for upward of 20 percent of the industry’s total incremental investment, is also rapidly becoming global as Western companies move into the developing world and acquire inefficient assets suffering from years of underinvestment.

Brazil, China, and India are among the countries with the greatest need for foreign investment, and it is here that the global players have been most active. Take Brazil. With its federal and state governments awash in debt, it had little choice but to privatize many of its utilities and to restructure the laws and regulations governing its electricity market so that foreign companies could compete. The result has been a major influx of global giants—notably AES, Endesa, Enron, and Iberdrola—into the Brazilian market.

The importance of scale

If deregulation and the need for capital make globalization possible, the pursuit of scale explains why individual companies globalize—and, in particular, why they reaggregate in horizontal slices of the value chain. With opportunities in traditional markets dwindling, companies must extend their horizontal integration to grow and to drive down their costs.

Although the delivery of power is fundamentally a local or at most regional activity, savvy global players will find most other slivers of the business system up for grabs. As we have already seen, meter reading—traditionally a service of distribution companies—has been targeted by a handful of automated meter-reading manufacturers that seek to leverage their investment in R&D and to reduce their manufacturing costs. Scale is also important in many other slivers, particularly if they rely heavily on systems (customer billing and energy trading), can be provided remotely (engineering and customer service), or require an initial investment to build up skills (development and retailing).

Efficient scale in many utility slivers will be much larger than the opportunity that any one utility franchise can provide. Such professional call-center operators as APAC or Sitel, for instance, may have upward of 8,000 workstations—an order of magnitude greater than even the largest US investor-owned utilities. The need to compete with such low-cost service providers will require growth far beyond the current scale of most utilities.

Management arbitrage

Even for slivers in which scale does not loom large, companies may want to globalize if the opportunity is big enough. The fourth driver of globalization in electricity is therefore the opportunity for management arbitrage: the exploitation, by the better performers, of the productivity gap between themselves and other companies.

Huge prizes await companies that bring less productive players up to best practice

Much of the electric power industry has been geographically segregated, so these gaps are sometimes enormous, and huge prizes await companies that can bring less productive players up to best practice. In the United States, for instance, $23 billion in pretax earnings would be created if all power generation plants met the productivity standards of the best ones. Similarly, $45 billion in pretax earnings would come into existence if transmission and distribution, on the one hand, and operations and maintenance, on the other, were brought up to best practice.²

In the world as a whole, the opportunities for gain are even greater. Consider two basic comparisons. In the United States, the most efficient utilities serve 600 customers for each employee. In South America, labor productivity declines to 300 customers for each employee and in Asia further still, to 160. And whereas US transmission and distribution systems lose an average of 7 percent of the power they generate to dissipation and theft along the network of wires, the numbers rocket to 13 and 17 percent, respectively, in Asia and South America.

Strategies for the transition

These forces will have a twofold impact. First, the owners or operators of some or all aspects of the electric power industry will be global rather than local players; second, the value chain will be "sliverized" as firms begin to specialize. Both developments are measurably under way. The transfer of ownership from local to global players through privatization and inter-national M&A has increased significantly. Around the world, the pace of privatization has increased more than fivefold, from $10 billion in 1993—94 to $32 billion in 1995-96 to $56 billion in 1997-98. Of these privatization transactions, 43 percent occurred in the developing economies of South America, where Western companies have eagerly snatched up generation and distribution assets.

The number of mergers and acquisitions has increased dramatically, too, as a quick glance at the headlines in 1997 and 1998 shows: "Scottish Power [United Kingdom] buys PacifiCorp [United States]"; "EdF [France] buys London Electricity [United Kingdom]"; "Endesa [Spain] buys Enersis [Chile]"; "Texas Utilities [United States] buys The Energy Group [United Kingdom]"; "Southern Company [United States] buys CEPA [Hong Kong]."

A bumpy ride

It is essential for companies to know how they will make money during the transition to full competition

Players in the power industry must have a sense of its ultimate end state. But it is far more important for them to understand how they will make money during the transition and to position themselves for it, since much value stands to be gained at this point, when commodity markets will be ill-formed and inefficient and regulators will be playing catch-up.

For stakeholders of all sorts, the ride is likely to be bumpy. Shareholders will push to make sure that they are not left holding the bag on stranded costs. The largest customers will demand early rate relief; claims that global competitiveness and the creation of jobs depend on it will resound in local headlines. Ratepayer advocacy groups will work to ensure that residential customers are not put at a disadvantage. And regulators will attempt to oversee the transition in as orderly a fashion as possible, trying to ensure that the lights stay on and customers benefit from the change.

Incumbents will face enormous challenges as their systems become increas-ingly exposed to the strategies of aggressive new entrants. But incumbents will be able to leverage their many local advantages, such as brand recognition and regulatory relationships, as well as any others they can build or buy. Moreover, their knowledge of the whole business chain and all of its inefficiencies will be a major—and unique—source of strength during the transition. They should leverage all of these sources of power, for during the next few transitional years the stakes will be highest and leveraging asset positions across the traditional chain of generation, distribution, and customer service will create and destroy the most value. At this time, too, strategies to shape the regulatory environment will make economic rewards flow into the coffers of certain players and not others, and early movers will establish positions that will permit them to capture a disproportionate share of future growth and opportunities.

Two strategies

Managers who must capture significant value during the transition and create a basis for a long-term role as the industry disaggregates can follow either of two potentially successful strategies: specialization or geographic integration.

Specialization. The first broad strategy is to become a global specialist and leader in one of the emerging slivers, as such competitors as Enron, Cellnet, and AES have done by exploiting their distinctive technical know-how or financial acumen to build formidable global positions. More and more, these companies and others like them set benchmarks around the world.

Enron, successfully pursuing multiple slivers, transformed itself from a North American gas pipeline operator into one of the world’s dominant gas and electric power companies, with growth potential in other commodities—pulp, paper, and, most recently, water—as well. From Enron’s initial gas pipeline platform and in-depth knowledge of the North American gas industry, the company invested to build capabilities in electric power (by developing power plants), gas trading, and risk intermediation services. All three platforms supported an aggressive global growth strategy. In gas transmission, this led to the development of the huge Brazil—Bolivia pipeline and the TGS pipeline in Argentina. In independent power, Enron has become one of the world’s largest producers, with a number of "milestone" projects in its portfolio. In trading and risk management, the company has expanded from gas into electricity and such nonenergy commodities as pulp and paper, and it has gone global in such markets as the United Kingdom and Scandinavia. Enron also recently made an acquisition to enter the water industry in the United Kingdom, where the company can leverage its operational skills, development experience, and risk management capabilities.

Cellnet is exploiting specialized technical skills in remote metering to build a distinct sliver business in which the returns to scale are likely to be very great. As a result, the company is approaching this market as a global game, using partnerships with Bechtel and Siemens to gain access to new infrastructure around the world.

As for AES, it was among the first companies to globalize a sliver—in its case, the development and operation of new generating facilities. During the 1980s, the company was an independent power producer focused entirely on the US market. In the early 1990s, anticipating that this would ebb and realizing that the most significant opportunities lay overseas, AES exported its know-how around the world, and by 1997 almost 90 percent of its generating capacity lay outside the United States. Although the company recently entered the wires business in Argentina, Brazil, Illinois, and Kazakhstan, it still focuses primarily on its core business.

Specialist players like these may not seem to have found a compelling approach to business, but when some of the local slivers are aggregated on a global basis, the story looks very different. The global metering industry, for instance, will probably become larger than 90 percent of the utilities in the United States. But to pursue a global sliver, a company must have intangible assets—skills, patents, and brand recognition—that are truly world class, not merely the best in the industry. These assets must be globally transportable; a strong brand in the UK retail market, for example, may not be effective in Brazil or the United States.

Meeting this standard will be a real challenge for today’s integrated utilities, all of which must refocus their currently fragmented efforts on much narrower parts of the value chain. Without such a focus, companies probably will not succeed in creating distinctive sets of intangibles capable of dominating the market.

Regional integrators. The second core strategy, to become the regional integrator of specialist services, will allow many incumbents to leverage their unique advantages, such as relationships with customers, regulators, and suppliers, as well as brand recognition and market insight. This will also provide the coordination mechanism needed to make it possible for the global specialists to provide world class service.

In our research into best-in-class utilities, we looked for the lowest-cost distributors of electricity. The most efficient one we found had an unusual focus on planning and integration, as well as the highest degree of outsourced services in the sample. To some extent, this company was already playing the role of a geographic integrator of the more specialized skills of other companies. By doing so, it achieved a 20-30 percent cost advantage relative to the best-performing utilities in the United States and the United Kingdom.

This integration strategy will attract many companies because it most closely resembles the current business structure of integrated utilities. Yet not all companies that try the integration game will win at it. For integrators, the challenge is threefold: to use their strong brands and relationships to develop truly advantageous access to market opportunities, to strengthen their customer marketing and partnering skills so that they continue to have a role as the industry disaggregates, and to outsource slivers of the value chain to the emerging specialists to reap the benefits of globalization.

These are strategies for the long term. During the transition, many other options will undoubtedly create real value for shareholders. Several companies, particularly AES and Endesa, are building regionally integrated positions to capitalize on the current inefficiencies of markets. The benefits of this course will be large but temporary; as the industry evolves, such players will have to force themselves to reach a higher level of performance, with the help of the skills and expertise of the specialists whenever appropriate.

First, power companies will have to decide whether they have the skills—and the stomach—for the fight. They should be working now to develop and hone intangible assets that facilitate access to new opportunities or can be transported around the world. Current skills and intangibles, market access, growth objectives, and appetite for risk will all influence a company’s choice between the two roles of integrator or sliver player along the value chain. Although opting for a narrow focus will not absolutely deprive companies of opportunities to try thoughtful option plays in other areas of the business, these plays will involve big strategic bets.

Power markets are opening up now, providing a wealth of new opportunities. In this uncertain market, many companies are investing in a multitude of new businesses or pursuing deal-driven growth to create options. But unless these deals or option plays are carefully designed and managed in such a way as to raise the intangible skills of a company above those of most of its competitors, success in the globalizing power market may well be elusive.